- The Wall Street Journal – Fed Officials Expected to Keep Rates Steady
Federal Reserve officials are likely to keep interest rates steady at their policy meeting this week and drill down into details about when and how to reduce their large holdings of mortgage and Treasury securities. The challenge in their postmeeting policy statement will be to acknowledge the handful of disappointing economic growth indicators since officials last gathered in mid-March without suggesting they are ready to veer from the policy path they have sketched out at recent meetings. The two-day policy meeting begins Tuesday. - The Financial Times – Fed edges gingerly towards talk of shrinking its balance sheet
The coming shake-up in the Fed’s balance sheet may end up being far less radical than some investors have believed. The Fed will need to operate with a much larger balance sheet than before the crisis — at least three times as big, say some investors — in part because of regulatory and other changes governing financial institutions’ appetite for safe assets, as well as an overhaul of the Fed’s rate-setting framework…To date the markets have appeared unperturbed by the crescendo of Fed talk over balance sheet shrinkage. This is in part because of growing signs that the reduction may be modest. A number of economists expect the balance sheet to settle at $3tn or bigger once a very gradual process of shrinkage has taken place…Ben Bernanke, the Fed’s former chairman, has said that the critical level of reserves needed for the Fed to transmit its monetary policy through the floor system involving excess reserves is well over $1tn. A recent annual report from the New York Fed’s markets desk sketches out scenarios of reserves being anywhere between $100bn to $1tn in the longer term. - Bloomberg – Fed’s Cut in Huge Bond Holdings May Be Messier Than Yellen Hopes
Federal Reserve Chair Janet Yellen has said she wants to shrink the central bank’s $4.5 trillion balance sheet in an “orderly and predictable way” that limits risks to the economy. The hurdles are high to getting that done. The economic impact, the pace of the drawdown and its ultimate end point are all partly subject to forces beyond the Fed’s control. That could mean that the financial markets and the economy may be in for more tumultuous times than Yellen and her colleagues are hoping for. “We don’t really know how it’s going to go,” said Richard Clarida, global strategic adviser for Pacific Investment Management Co., which oversees $1.5 trillion in assets. “There’s not all that much precedent” for the position that the Fed finds itself in…The reaction of the financial markets to the Fed’s emerging balance-sheet strategy so far has been muted, boosting policy makers’ hopes that the drawdown can go off without much trouble.
Comment
While the Fed sees muted markets as a sign of acceptance of balance sheet reduction, we recently offered a different interpretation:
We do not agree with Fischer’s assessment that the market has accepted a reduced balance sheet simply because the markets have remained calm. Has it occurred to Fed officials that they have a credibility problem and the market does not believe them? Recall it was Fischer that said four hikes were “in the ballpark” for 2016. Obviously, this turned out to be off base.
Consider some of the other topics we highlight today. Q1 GDP projections continue lower, the retail industry is struggling, inflation expectations are at their lowest point of the year and the political landscape is creating a large degree of uncertainty. Rather than interpreting the market calm as a sign that the market has accepted a reduced balance sheet, as Fischer has, we think the market is simply focused on the deteriorating factors mentioned above. They think the Fed will be hard-pressed to tighten, whether it be by hiking rates or reducing the balance sheet, in such an environment.