Federal Reserve likely to begin cutting back $4.5 trillion balance sheet this year – Washington Post

Before the end of this year, the Federal Reserve will likely begin paring back the $4.5 trillion balance sheet it amassed as it tried to prop up the nation’s economy during the recession, yet another sign of the U.S. economy’s continued progress since the financial crisis.

Minutes of the Fed’s March policy meeting released Wednesday showed central bank officials considering how to unwind its massive balance sheet, whether to move more quickly to keep inflation in check and when to prepare for the Trump administration’s promised stimulus projects.

“Provided that the economy continued to perform about as expected, most participants anticipated that gradual increase in the federal funds rate would continue and judged that a change to the Committee’s reinvestment policy would likely be appropriate later this year,” the minutes read.

The U.S. central bank has already begun the process of raising interest rates back to more normal levels after holding them near zero for years to buoy the economy during the financial crisis. The U.S. job market continues to strengthen, and business and consumer confidence have spiked in recent months. In March, the Fed raised its benchmark interest rate for the second time in a year and said it expects two more rate hikes this year and three more next year.

[Fed raises rates amid signs of strengthening economy]

But the Fed has yet to begin significantly reducing the massive amount of Treasurys and mortgage-backed securities it purchased during the financial crisis to try to spur lending and keep interest rates low. Some observers argue that these holdings are weighing on long-term interest rates and that the Fed should not intervene so heavily in the markets.

As the economy continues to gather strength, the Fed aims to gradually remove its support and let the economy stand on its own. If the Fed sells off its holdings too quickly, that could trigger a sudden drop in the price of those assets or a spike in interest rates, potentially upsetting markets.

The minutes showed that Fed officials mostly preferred to tie the change to the strength of the economy — and to gradually phase out reinvestments of the proceeds from the Treasury and mortgage-backed securities that mature, rather than suddenly ceasing reinvestments altogether. That would allow the Fed’s balance sheet to gradually run down in a process that is likely to take years.

 [High-ranking Fed official resigns, reveals role in leaked confidential information]

“I think the operative word here is going to be gradual. They’re not going to want to go cold turkey,” said Josh Feinman, global chief economist for Deutsche Asset Management. “They don’t want to do anything disruptive.”

Most economists believe the U.S. economy is strong enough to sustain gradual increases in the interest rate and that the Fed should now shift its focus to restraining emerging inflation.

A survey of private payrolls released by ADP on Wednesday showed companies added 263,000 workers in March, the largest gain since December 2014. The personal consumption expenditures index, a measure of inflation watched by the Fed, rose 2.1 percent year-on-year in February, the largest gain in nearly five years, while a core PCE index, which excludes volatile energy and food prices, rose 1.8 percent.

[U.S. trade deficit shrinks as global economy gathers strength]

According to the minutes of the March meeting, Fed officials are keeping a closer watch on inflation but don’t yet believe it is meeting their 2 percent target on a sustained basis. Fed officials have argued that the recent recovery in oil prices appears to be driving increases in inflation and that energy prices can fluctuate significantly.

The federal government is set to release its official report on employment on Friday. Strong data could encourage the Fed to announce another rate hike at its upcoming June meeting.

On Wednesday morning, before the release of the minutes, the futures market was forecasting a 4 percent probability of a rate hike in May and a 63 percent probability of a hike in June.

Stock markets have surged in recent months on expectations that the Trump White House will introduce measures to stimulate the economy, including tax cuts for individuals and corporations and programs that boost infrastructure spending. If the measures do come later this year, it’s possible the Fed would have to raise rates more quickly to offset inflation. Yet the administration has confronted early hurdles pushing its tax and health-care plans through Congress, and ambitious promises from the campaign trail on trade and infrastructure have not yet been met.

 [The U.S. economy just got hit with a disturbing piece of bad news]

At the March meeting, Fed officials expressed continued uncertainty about how the White House’s policies would affect the economy, with only about half of the Fed’s voting members incorporating assumptions about fiscal policy into their economic projections.

“Several participants now anticipated that meaningful fiscal stimulus would likely not begin until 2018,” the minutes read. “ … some participants and their business contacts saw downside risks to labor force and economic growth from possible changes to other government policies, such as those affecting immigration and trade.”

The Fed is increasingly encouraged by progress in the global economy, including stronger growth in China and Europe, the minutes showed. However, officials pointed to upcoming elections in Europe, which could trigger the exit of more countries from the euro zone, as a possible risk to the global economy.

At a news conference last month, Fed chair Janet Yellen emphasize that the committee wants to use changes in the short-term interest rate target as its main tool for influencing monetary policy, not the balance sheet. The balance sheet is “not a tool that we would want to use as a routine tool of policy,” she said.

Feinman said the central bank may be eager to begin unwinding the balance sheet before Yellen’s term as chair expires early next year, to ensure that process continues under new leadership. “When the process is underway, the Fed doesn’t like to shake the trees too much. That’s another reason I think they would like to get this plan articulated, announced and on its way before Yellen leaves,” he said.

Fed watchers were stunned on Tuesday by news of the sudden resignation of Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, after Lacker acknowledged that he had played a role in a leak of confidential information on monetary policy to a financial analyst several years ago.

Lacker’s resignation also casts uncertainty on the make-up of the central bank’s top leadership. Two positions are open on the Fed’s Board of Governors, while another was set to be vacated on Friday with the resignation of Daniel Tarullo. The terms of Yellen as chair and Stanley Fischer as vice chair of the Federal Reserve system will expire in early 2018, though both could choose to remain on the Board of Governors.

Federal Reserve likely to begin cutting back $4.5 trillion balance sheet this year – Washington Post

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