By Yasin Ebrahim
Investing.com – Federal Reserve officials discussed the prospect of stepping up the pace of monetary policy tightening including plans to cut the size of the central bank’s balance sheet after the May meeting, the Fed’s March meeting showed Wednesday.
“[P]articipants agreed they had made substantial progress on the plan and that the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May, “according to the Fed minutes.
At the conclusion of its previous meeting on Mar. 16, the Federal Open Market Committee, the Fed’s rate-setting arm, raised its to a range of 0.25% to 0.5%.
The Fed’s decision in March was also accompanied by several projections on the path of economic growth, inflation, and unemployment.
But it was the central bank’s estimates on rate hikes that caught many by surprise. Fed members seemingly backed six rate hikes for 2022, forecasting the benchmark rate to rise to 1.9% by year-end.
Ahead of the minutes, Fed members appear to be teeing up the market for a much steeper tightening path than previously projected as inflation has not shown any sign of dissipating.
The Federal Reserve’s preferred inflation measure, the personal consumption expenditures (PCE) price index excluding food and energy, rose 5.4% in the 12 months through March, the fastest gain since April 1983.
The Fed is “prepared to take stronger action, if indicators of inflation and inflation expectations indicate that such action is warranted,” Federal Reserve Governor Lael Brainard said on Tuesday.
About 80% of traders expect the Fed to hike rates by 50 basis points at its May meeting, according to Investing.com’s
Raising rates is not the only tool in the Fed’s monetary policy toolbox. The Fed can also shrink its nearly $ 9 trillion balance sheet, a move which Powell suggested last month “might be the equivalent of another rate increase.”
History proves, however, that the balance sheet reduction operation, or quantitative tightening, is not an easy task.
In 2018, the Fed allowed certain bonds to ‘run off’ each month without reinvesting the principal of the bonds, primarily US Treasury and mortgage-backed securities, in new securities.
Opting for a gradual and capped approach, the Fed allowed about $ 10 billion of securities a month – $ 6 billion a month in Treasury securities and $ 4 billion in mortgage-backed securities a month – to roll off its balance sheet, with a view to gradually speed up the process.
But as the pace of the runoff reached $ 50 billion a month, the central bank was forced to stop the process in late 2019 after a key short-term overnight lending rate, which supports the plumbing of the financial system, jumped and risked the stability of funding markets.
Powell, pointing to the strength of the economy, believes this time it’s different.
The hawkish wave of remarks from Fed members has not gone unnoticed. The bond market appears to be pricing in the growing risk that the US central bank will overshoot on tightening and slow the economy excessively, which could ultimately result in a recession.
A key part of the yield curve, the over 2-year Treasury yield, briefly inverted recently, a warning sign that a recession could be on the horizon.
Deutsche Bank (DE 🙂 was one of the first major banks to warn that the US will fall into recession next year amid expectations for the Fed to hike rates by 50 basis points at each of its next three meetings.
“The US economy is expected to take a major hit from the extra Fed tightening by late next year and early 2024,” Deutsche Bank economists David Folkerts-Landau and Peter Hooper said in a report on Tuesday.