US Fed set to shrink balance sheet

06 April, 2017, 02:52 | Author: Elaine Woods

The minutes recorded the views of policymakers expressed at a March 14 - 15 meeting, when they voted to raise their benchmark interest rates to head off mounting inflation.

The Fed, chaired by Janet Yellen, bought Treasury and mortgage-backed bonds on a hitherto unprecedented scale in the wake of the financial crisis to help to keep interest rates low and to encourage job creation and economic growth.

The Fed used both the federal funds rate and securities purchases to drive down interest rates across the board about a decade ago, but needs to boost those rates once more now that the unemployment rate has remained below 5 percent for almost a year and inflation has hit the Fed's target level of 2 percent, meaning the economy is humming right along.

"The December FOMC meeting is probably the most likely date to introduce this change", said Paul Ashworth, chief US economist at Capital Economics in Toronto, following the publication of the minutes.

The most recent projections from the Federal Open Market Committee, which sets the Fed's benchmark rates, were for a total of three rate hikes in 2017.

"The FOMC minutes were clear that officials are contemplating beginning to address the balance sheet", said Win Thin, an economist at Brown Brothers Harriman.

The minutes said one approach for reducing the holdings that was discussed would be to suspend the reinvestment of at least some of the holdings of Treasury bonds and mortgage-backed securities as they mature.

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Minutes of the Fed's March policy meeting, released Wednesday, contained details of the central bank's first intensive discussion of how to unwind its massive balance sheet.

Most economists believe the USA 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.

As the newly-released minutes indicated, the Fed could very soon begin selling those assets off, triggering a speedier rise in general interest rates, and, as a result of the rise in the cost of borrowing, a potential market panic and fears of economic slowdown.

The minutes said that because of the "substantial uncertainties" about the outlines of the program that might eventually emerge from Congress, about half the Fed officials had included no assumptions about Trump's efforts in their economic forecasts.

On inflation, the minutes showed that some Fed officials anxious that if unemployment, now at a low of 4.7 percent, fell even further, it could pose a "significant upside risk" of higher inflation.

"Several participants now anticipated that meaningful fiscal stimulus would likely not begin until 2018, " the minutes read. The Fed's dual mandates are to achieve maximum employment and moderate inflation.

In its March policy statement, the Fed said that its inflation target was "symmetric", indicating it could tolerate price rises temporarily overshooting its 2 percent target rate. Unemployment is already below the Fed's 4.8 per cent goal, while inflation has remained below its 2 per cent inflation goal for several years.

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