– Fed Officials Generally Agree on Rising Caps on Bond Run-Offs
– Minutes Give Strong Signal For A Possible June Hike
By Steven K. Beckner
Written exclusively for InTouch Capital Markets
25th May 2017
The determination of Federal Reserve policymakers to move ahead fairly soon on shrinking the Fed’s bloated balance sheet is on display in the minutes of their May 2-3 Federal Open Market Committee meeting released Wednesday.
The FOMC has been holding discussions all year on how and when to shrink the balance sheet by curtailing reinvestments of the proceeds of maturing securities, and those talks are bearing fruit sooner than many once thought.
Not only did the FOMC continue talking about scaling back reinvestments in early May, participants reached a high level of agreement on roughly how to proceed, while reiterating the likelihood of making a start “this year.”
At their mid-March meeting, you’ll recall, minutes revealed that “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.”
Now, the May minutes provide a general blueprint for doing just that. It’s in keeping with the “gradual and predictable” approach for which Fed officials have long expressed a preference.
The Fed governors and presidents received another briefing from the Fed staff on “a possible operational approach to reducing the System’s securities holdings,” the minutes say.
The staff proposed that the FOMC “would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month.”
“As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger,” the minutes continue.
“The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels,” the minutes go on. “The final values of the caps would then be maintained until the size of the balance sheet was normalized.”
In other words, after a relatively modest start, the Fed would steadily reduce the amount of reinvestments and rollovers, i.e. increase the amount of run-offs. The numbers have yet to be determined and are subject to further discussion at next month’s meeting and beyond.
The staff proposal seems to have been acclaimed by the FOMC members. The minutes say “nearly all policymakers expressed a favorable view of this general approach.”
“Policymakers noted that preannouncing a schedule of gradually increasing caps to limit the amounts of securities that could run off in any given month was consistent with the Committee’s intention to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner as stated in the Committee’s Policy Normalization Principles and Plans,” according to the minutes.
“Limiting the magnitude of the monthly reductions in the Federal Reserve’s securities holdings on an ongoing basis could help mitigate the risk of adverse effects on market functioning or outsized effects on interest rates,” the policymakers felt.
What’s more, they agreed that “the approach would also likely be fairly straightforward to communicate.”
“Moreover,” the minutes disclose, “under this approach, the process of reducing the Federal Reserve’s securities holdings, once begun, could likely proceed without a need for the Committee to make adjustments as long as there was no material deterioration in the economic outlook.”
The seemingly broad agreement on this incremental but escalating approach to scaling back reinvestments marks significant progress on the road to shrinking the Fed’s $4.5 trillion balance sheet.
Principles and Plans should be augmented soon to provide additional details about the operational plan to reduce the Federal Reserve’s securities holdings over time.”
What’s more, the minutes add, “Nearly all policymakers indicated that as long as the economy and the path of the federal funds rate evolved as currently expected, it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year.”
This sets the stage for the FOMC to take further steps toward cutting the size of the balance sheet at its June 13-14 meeting, after which Chair Janet Yellen will have a chance to elaborate on balance sheet strategy.
On the interest rate side of monetary policy, the minutes tell us that if the economy performs as expected, i.e. if it rebounds from “transitory” first quarter weakness, most FOMC participants judged “it would soon be appropriate for the Committee to take another step in removing some policy accommodation.”
That sounds like a strong signal of a probable June rate hike.
Prior article by Steven Beckner for InTouch Capital Markets: FOMC Minutes Dated But Could Still Give Useful Clues
Steven Beckner is a veteran financial journalist with four decades of experience of reporting on the Federal Reserve. Mr Beckner is also the author of Back From The Brink: The Greenspan Years (Wiley, 1997) and can also be heard speaking regularly for National Public Radio.