Fed’s Mester backs shrinking balance sheet ‘as fast as we can’ without pushing markets off track

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Cleveland Fed Chair Loretta Meester said on Wednesday that she wants the central bank to quickly shrink its balance sheet so that it comes to a “more reasonable size” as long as the momentum does not negatively affect financial markets. Is.

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During the COVID-19 pandemic and Treasury market disruption, the Fed bought securities. The central bank’s balance sheet doubled to $8.8 trillion.

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The Fed is actively planning to move away from its over-easing policy stance when the economy has restarted during the pandemic shutdown, balance sheets are shrinking and interest rate hikes are on the table.

Financial markets are watching the balance sheet debate closely. Trader after trader has appeared on Cable Business Network since 2020, saying that the Fed’s asset purchases, sometimes referred to as quantitative easing, have strengthened financial asset valuations. And so there is a feeling that the opposite may also be true.

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In an interview at the Wall Street Journal’s CFO Network Summit, Meester, who is a voting member of the Fed’s interest rate setting committee this year, said she wants to shrink the balance sheet. He said the Fed may shrink portfolios at a faster pace than in 2017 because the economy is strong and the balance sheet is large.

“I want to reduce this – let me say this carefully, so that people don’t misunderstand – as soon as we can, on condition of not disrupting the functioning of the financial markets,” Meester said.

On Tuesday, Kansas City Fed Chairman Esther George, who is also a FOMC member this year, supported the faster pace of shrinking the balance sheet.

Fed’s George urges sharp decline in assets

The Fed shortened its balance sheet in 2017 by allowing a portion of its maturing securities to be rolled off the balance sheet every month. It did not sell any of its portfolio holdings.

In 2017, the Fed began allowing $10 billion a month rolling in and eventually raised it to $50 billion a month. The balance sheet shrank from a peak of $4.5 trillion in January 2015 to $3.8 trillion in August 2019.

One thing that’s different this time around is that the Fed has a new permanent repo facility to provide liquidity to the market in case any stress emerges as the balance sheet shrinks. The strain emerged in the last cycle in September 2019.

There are “rules of thumb” about the amount of balance sheet shrinkage equivalent to a quarter-point increase in the Fed’s benchmark interest rates. But these studies always emphasize that it depends on current economic conditions, Meester said.

“I think we should be humble” about the specific implications of shrinking the balance sheet, she said.

“I think what we need to do is determine an appropriate path to shrink the balance sheet” and then see how the economy reacts when the Fed raises its benchmark rate, she said. The two policy tools will move in the same direction.

With interest rates at zero, and the Fed still buying assets until mid-March, the central bank is a long way from keeping tight monetary policy, she noted.

Fed Chairman Jerome Powell told Congress on Tuesday that the balance sheet could shrink later this year. Some Fed officials are pushing for an earlier start.

Powell sketches a soft landing

Barclays chief US economist Michael Gapen said he expects the balance sheet to start shrinking in the second half of the year.

He estimated the Fed is looking to remove $1 trillion from the balance sheet in the first year.

In a Businesshala Radio interview, he said, “I think they can get pretty fast in the beginning, probably about $60 billion-$80 billion a month after a slow start.

The Fed has more short-term T-bills on its balance sheet than in 2017.

“You can get a lot of runoff very fast by just letting go of T-bills,” Gapen said.

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and yields on the 10-year Treasury note TMUBMUSD10Y were higher on Wednesday,
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fell to 1.716%.

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