Federal Reserve officials will use their first meeting of 2022 in ten days to lay the groundwork for moving away from their too-easy currency stance toward more general policy during the pandemic.
Officials have now been silent for almost two weeks ahead of a meeting to prepare for an interest rate setting meeting.
In a flurry of speeches over the past two weeks, hawks and doves at the central bank allude about the way forward. US inflation is very high, the unemployment rate is below its neutral rate, and economic momentum should strengthen after the coronavirus Omicron wave has passed.
See: Fed’s harks see ‘reasonable amount of tightening’ this year
“We have heard from a lot of officials at this point. There seems to be a broad consensus that they are going to raise rates in March,” said Matthew Luzzetti, chief US economist at Deutsche Bank, in an interview. that the quantitative tightening should not start sometime after starting the rate hike,”
“The most important discussion points at the January meeting will be further guidance regarding the timeline for the quantitative tightening and the start of the potential monthly drawdown that we can expect,” Luzzetti said.
He said that he would like to get closer to the final decision on these issues.
The Fed will still purchase Treasury bonds and mortgage-backed securities until mid-March.
Fed officials this week threw a wet blanket on speculation by some economists that the central bank would decide to abruptly end its asset purchases in January.
In a speech on Friday, New York Fed Chairman John Williams gave every indication that the Fed would stick to the timeline for the tapering of bond purchases adopted in December “and will not end quantitative easing in early January, even if it raises rates in March.” Evercore ISI vice chairman Krishna Guha said in a research note.
See: Fed’s Williams sees slowdown in inflation this year due to slowdown in growth
Deutsche Bank’s Luzzetti thinks the Fed will announce a balance sheet shrink in July.
He expects the Fed to allow $20 billion of treasuries and $15 billion of mortgage-backed securities to close each month initially, and increase those monthly drawdowns to between $60 billion and $45 billion by the end of the year.
He said the Fed would allow all Treasury bills to run on its portfolio. All told, that’s a shortfall of $560 billion this year. A rule of thumb from the last tightening cycle in 2017 suggests that roughly a 3-quarter-point equates to a hike in fed funds rates, but that’s a rough estimate, Luzzetti said.
During the pandemic, the Fed doubled its balance sheet to about $8.8 trillion.
The highest US inflation reading in 40 years and a steady decline in the unemployment rate have forced the Fed to shy away from an easier policy stance since the start of 2020 when the pandemic hit.
Oxford Economics economist Oren Klatchkin sees four quarter-point rate hikes this year and the beginning of a balance sheet reduction by mid-year.
He said there would be a winter economic soft patch from spiking omicron cases but added that activity would return in the spring. He said this year should still see “solid” economic growth. Economists said the US GDP is expected to grow at 5% in 2021, the fastest pace in 30 years.