Federal Reserve officials are likely to raise short-term interest rates at their meeting in two weeks and announce their framework for shrinking a $4.5 trillion portfolio of bonds and other assets later this year.
Clarity on these two matters has allowed them to focus on two other looming decisions this year -- whether to raise rates again in September and when to start reducing the portfolio, or balance sheet.
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One source of uncertainty emerging in recent weeks is the possibility that Congress and the White House might have trouble reaching agreement in September to raise the federal debt limit and approve government funding for the year beginning Oct. 1.
Until recently, many officials thought they would probably want to lift rates in September and start the balance-sheet process later in the year. But now some say they may want to rethink the timing of those plans if a rancorous budget fight threatens to roil markets.
For now, though, Fed policy is on a smooth track. At their May meeting, officials forged consensus around a strategy for slowly and predictably reducing the balance sheet of Treasury securities and mortgages by allowing a small number of assets to mature every month without reinvesting any proceeds, according to interviews and their public statements.
The Fed would start by allowing a small amount of net maturities per month, and allow that amount to rise each quarter. It has not yet outlined those amounts. Officials are unlikely to say how big the portfolio will be at the end of the process until it is further along.
The agreement on this approach could be announced as soon as June 14, after its two-day policy meeting.
Officials are likely to vote then to raise their benchmark short-term rate by a quarter percentage point to a range between 1% and 1.25%. They also will release new economic and rate projections for the rest of the year, which will likely indicate they still expect to raise rates again later this year.
The Fed's path ahead is "the most telegraphed monetary policy of our lifetimes," San Francisco Fed President John Williams said Monday at a conference in Singapore.
Fed Chairwoman Janet Yellen is set to take questions from reporters after the June meeting, which would let her explain the central bank's intentions in detail.
After raising rates in March, many officials thought it likely they would move again in June and September. A tentative plan emerged to pause rate increases at the end of the year and start shrinking the portfolio then. Now, however, the looming debt-limit fight has some officials pondering whether they might delay the third rate increase until after September or initiate the portfolio wind-down sooner, perhaps as early as September, if the economy evolves as they expect.
Standoffs between Republicans and the Obama administration repeatedly pushed the envelope on debt-ceiling brinkmanship, unsettling markets. This is the first time the Trump administration navigates the issue with sometimes unruly GOP congressional majorities.
While the deadlines have been well known for months, it isn't yet clear how Congress and the administration will resolve the issue. One sign of the new administration's unpredictability came earlier this month after President Donald Trump agreed to a short-term funding bill. Mr. Trump said on Twitter the U.S. might benefit from a "good shutdown" this fall to force a confrontation over government spending.
The Treasury Department began employing emergency cash-conservation steps in March to avoid breaching the federal borrowing limit, set at $19.9 trillion, after a 16-month suspension of the debt ceiling expired.
Analysts initially said those steps might last into the fall, but Treasury Secretary Steven Mnuchin last week asked Congress to raise the borrowing limit before lawmakers head home for their August recess. White House budget director Mick Mulvaney told lawmakers that was necessary because federal receipts have been coming in "a little bit slower than expected," whittling down the Treasury's cash balance.
Congress must also reach agreement to extend government funding that expires Sept. 30, creating the potential for additional wrangling.
In 2011, Standard & Poor's downgraded the U.S. triple-A credit rating for the first time after Treasury came within days of being unable to pay some bills. In 2013, the U.S. government endured a 16-day long shutdown that ended with a bill to extend the debt limit. Congress agreed to the most recent extension in October 2015 after then-House Speaker John Boehner cut a deal with the White House.
Fed officials have changed plans before when political uncertainty threatened to stir financial turbulence. They had tentatively planned to raise rates in June, but held off out of concern the U.K. vote on leaving the European Union might cause market upheaval. They waited until after the U.S. presidential election before raising rates at the end of 2016.
Another issue for Fed officials to consider as they look beyond their June meeting is the recent slowdown in inflation. They indicated at their May 2-3 meeting they were prepared to look past a surprise ebbing in March, but the Labor Department's consumer-price index also weakened in April. Prices excluding food and energy in the Fed's preferred inflation gauge, due for release Tuesday, are expected to show an annual increase of just 1.5% in April.
If the inflation slowdown does prove transitory, Fed officials should stay on track to raise in June and again later this year.
Officials currently place more emphasis on the strong labor market. Steady job gains that have pushed a range of employment measures to their sturdiest levels in nearly a decade, including an unemployment rate at 4.4% in April. The May employment report is scheduled for release Friday.
Officials say they remain confident such low unemployment will be enough to lift inflation toward their 2% target in coming years, meeting the Fed's twin objectives of stable prices and maximum, sustainable employment.
"The U.S. economy is about as close to the Fed's dual mandate goals as we've ever been," Mr. Williams said Monday. In reaching those targets, "it is better to close in on the target carefully and avoid substantial overshooting," he said.
The process of shrinking the balance-sheet process should be predictable and boring with lots of advance notice to markets, "the policy equivalent of watching paint dry," Philadelphia Fed President Patrick Harker said last week.
Officials want to avoid a rerun of the 2013 "taper tantrum," when investor concerns over the Fed's decision to slow the pace of asset purchases triggered market turmoil, leading to a spike in Treasury yields and capital outflows from emerging markets.
The Fed stopped adding to the balance sheet more than three years ago, but has been reinvesting the proceeds of maturing assets to keep their holdings steady. Those reinvestments have helped to hold down long-term interest rates, and allowing them to roll off without reinvestment could push up long-term rates.
Markets have largely shrugged off the details of the plans as officials have dribbled them out, giving the Fed a green light to finalize them.
Write to Nick Timiraos at email@example.com
(END) Dow Jones Newswires
May 30, 2017 06:14 ET (10:14 GMT)