Fed Eyes More Rate Hikes, Balance Sheet Trimming Later This Year

By The Fed FOXBusiness

The Federal Reserve building in Washington September 1, 2015. REUTERS/Kevin Lamarque (Copyright Reuters 2017)

Alongside continued rate rises, the Federal Reserve is likely to begin trimming the $4.5 trillion in bonds on its balance sheet later this year, minutes from the central bank’s March meeting showed on Wednesday.

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In their discussion last month, participants in the Fed’s policy-setting Federal Open Market Committee (FOMC) emphasized that the process of reducing the balance sheet should be done in a predictable way so as not to surprise investors.

“Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the committee’s reinvestment policy would likely be appropriate later this year,” the minutes read.

To begin that process, some FOMC members prefer to phase out reinvestments of principle from assets – including Treasury securities and mortgage-backed securities – at maturity, which would reduce financial-market volatility, while others preferred ending reinvestments all at once, which would normalize the balance sheet much more quickly.

Up to this point, the Fed has maintained the size of its balance sheet by purchasing new bonds when old ones mature. By stopping the reinvestment, it would begin to slowly reduce the balance sheet, or let it “runoff.”

A clear sign the Fed is not ready to make any final decisions on the matter, the minutes showed committee members agreed more deliberation on the balance sheet would come at meetings later this year, and a final decision would be “communicated to the public well in advance of an actual change.” 

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Much of the assets sitting on the central bank’s balance sheet were a product of a monthly bond-buying program called quantitative easing, enacted in the wake of the 2008 financial crisis and was intended to help jump start the economy. Since then, the U.S. economy has made marked improvements as the unemployment rate holds below 5%, inflation has moved well within striking distance of the Fed’s 2% target, and consumers remain optimistic and spending at a robust rate.

Data from payroll processor ADP on Wednesday morning showed the private sector added 263,000 jobs in March, far more than the 180,000 Wall Street analysts expected. Though employment gains from the prior two months were revised lower, the data were a positive signal for the closely-watched non-farm payrolls report from the Labor Department due out on Friday. Economists are expecting to see that the U.S. added 180,000 net new jobs last month while the unemployment rate held steady at 4.7%.

While FOMC members expect to see a slower growth rate in the first quarter of 2017 from the fourth quarter of 2016, and uncertainty remains around the prospect of fiscal stimulus measures from Donald Trump’s administration, they view risks to the economy as “roughly balanced” and “far less pronounced” than in the “recent past.” That’s thanks in part to higher consumer and business confidence in recent months. Because of that, the committee agreed additional rate increases would likely be appropriate later this year. 

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