Halting Balance Sheet Reduction

28 February, 2019

Fed Minutes Recap: Halting Balance Sheet Reduction, Risks And Uncertainties

The U.S. Federal Reserve released the meeting minutes from the monetary policy meeting from early January. The central bank’s minutes showed that officials discussed ending the reduction in the central bank’s balance sheets before the end of this year.

The minutes showed that there were extensive discussions by officials about the market conditions. Also, there is an emphasis on the central bank’s actions on the markets including equities and bonds.

“Almost all participants thought that it would be desirable to announce before too long, a plan to stop reducing the Federal Reserve’s asset holdings later this year,” the minutes showed about halting the reduction in the balance sheets.

Fed Balance Sheet

Members thought that communicating this to the markets would bring about more certainty about the Fed’s balance sheet reduction and normalization.

Besides tightening monetary policy, the Federal Reserve has also been unwinding its massive asset purchases made under the guide one QE purchases, leading to over $3.8 trillion in bonds that were purchased by the central bank.

The Fed started to reduce its balance sheet in October 2017 as it allowed the level of proceeds to roll off every month. The central bank said that this process would continue seamlessly.

Members noted that the balance sheet reduction was one of the reasons for the market volatility in late 2018. However, in a survey of primary market dealers and market makers, the results showed that the balance sheet reduction was not responsible for the market volatility last year.

The outcome

The markets, on the other hand, reacted to the Fed continuing to reduce its balance sheet despite tightening financial conditions. The statement from the Fed’s minutes showed concerns from other members about the intentions to maintain its balance sheet reduction program to a level that officials were more comfortable with.

The central bank also maintained its stance on interest rates noting that it would remain patient in hiding interest rates. It said that the rate hikes were essential as officials weigh the headwinds to growth.

The minutes showed that “Participants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in mangling various risks and uncertainties in the outlook.”

Officials also discussed the recent softness in inflation and the impact of the partial government shutdown.

Members discussed the impact of the ongoing trade talks with China.

Officials believe that keeping interest rates unchanged at the current level of 2.25% – 2.50% poses fewer risks at this point. This is in contrast to previous statements where officials worried about keeping interest rates low for too long.

If Fed the members see the headwinds fading, then it would undoubtedly re-evaluate its current approach to interest rates. This means that if the economic conditions improve in the markets, the Fed would most likely start resuming interest rates. However, it should be in correlation to how inflation rises.

More action for markets later in March

The markets are currently assigning two rate hikes for this year. The next FOMC meeting is in March, where the central bank will give its economic outlook. The weeks ahead will see the U.S. data playing catch up as the delayed GDP reports are due.

Forecasts already show that the U.S. economy slowed in the fourth quarter of last year. Fed officials are likely to remain on the sidelines until the June FOMC meeting. This is due to the ongoing trade uncertainty with China and the outcome of the talks before the March deadline ends.

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