Fed moderately biased towards tightening as balance-sheet roll-off nears end

Published Thu, Feb 21, 2019 · 09:50 PM
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US FEDERAL Reserve policy makers see 2019 marking the end of their balance sheet run-off, but not necessarily their interest-rate increases.

Minutes of the central bank's Jan 29-30 policy meeting released on Wednesday (Thursday morning, Singapore time) showed "almost all participants" agreeing it best to halt roll-offs this year, a move that should be welcomed by investors worried the balance sheet draw-down is hurting the economy.

The news on interest rates was less friendly to financial markets, where some investors think the next move in interest rates might be down.

The minutes, instead, showed Fed officials were divided over what it would take for them to raise rates again. There was no suggestion of a cut.

"The debate is still focused on whether to tighten or not, and not whether to cut," said Wrightson ICAP chief economist Lou Crandall. "The risk is tilted in the direction of more tightening."

While US stocks edged higher after the release, the 10-year Treasury yield climbed to 2.64 per cent and the dollar erased losses.

Fed officials dedicated a large portion of their discussion to concerns over risks facing the US economy, ranging from slower growth in China and Europe and waning fiscal stimulus, to ongoing trade disputes and the complications from the UK exit from the European Union.

Due to those worries, several officials "nudged down their outlooks for output growth", the minutes showed.

The minutes also hammered home the point that officials would proceed cautiously. The record included a lengthy justification for being "patient" in deciding when and how next to adjust policy.

Still, all the discussion of downside risks and patience did not shift the debate into the territory where cuts came into view. Pricing in federal funds futures indicate a small chance that the Fed's next move will a rate cut.

"Several" policy makers indicated "if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year".

That was balanced by another group of "several" officials who "argued that rate increases might prove necessary only if inflation outcomes were higher than in their baseline outlook".

That left some economists convinced the minutes weren't quite as dovish as the message seemingly delivered on Jan 30, when the Fed dropped a longstanding reference in its statement to "further gradual increases" in rates, and replaced it with a promise to be patient in deciding the "timing and size of future adjustments."

Asked whether the term "adjustments" signalled the Fed's next move was just as likely to be a cut as a hike, Fed chairman Jerome Powell told reporters after the meeting that policy makers were not leaning strongly in either direction.

The "minutes suggest that the committee is probably still modestly biased toward the next move being a tightening, whereas the statement conveyed more of a flat neutral bias," Michael Feroli, the chief US economist at JPMorgan Chase, wrote in a note to clients.

That was echoed by Michael Gapen, chief US economist at Barclays: "The minutes, in our view, indicate that the committee retains some upward bias in its policy rate path."

On the balance sheet, the minutes said almost all officials agreed "it would be desirable to announce before too long a plan to stop reducing the Federal Reserve's asset holdings later this year".

Diane Swonk, chief economist at Grant Thornton, said she now expects the Fed will make that announcement in March.

Fed officials expanded their balance sheet dramatically as an emergency measure to calm debt markets and stimulate the economy during the financial crisis. The portfolio has declined to about US$4 trillion from a peak of US$4.5 trillion in 2015.

"They will have a permanently gigantic balance sheet," said Ward McCarthy, chief financial economist at Jefferies. "They always said it would be larger than pre-crisis, but earlier commentary suggested it would something significantly smaller." BLOOMBERG

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