Fed Members See Major Rate Hikes, Balance Sheet Trimming: Minutes from Investing.com


©Reuters.

By Yasin Ebrahim

Investing.com – Federal Reserve officials discussed the prospect of increasing the pace of monetary tightening, including plans to trim the central bank’s balance sheet after the May meeting, the Fed’s March meeting showed on Wednesday.

“[P]Participants agreed that they have made significant progress on the plan and that the committee is well positioned to begin the balance sheet downsizing process as soon as its upcoming May meeting concludes,” the Fed minutes said.

At the close of its last meeting on March 16, the Fed’s FOMC, the Fed’s rate-setting arm, raised its policy rate to a range of 0.25% to 0.5%.

The Fed’s decision in March was also accompanied by several forecasts on the course of economic growth, inflation and unemployment.

But it was the central bank’s rate hike estimates that surprised many. Fed members appeared to be backing six rate hikes for 2022 and forecast interest rates to rise to 1.9% by year-end.

Ahead of the minutes, Fed members appear to be taking the market on a much steeper tightening path than previously forecast as inflation has shown no signs of unwinding.

The Federal Reserve’s preferred measure of inflation, the personal consumption expenditure (PCE) price index excluding food and energy, rose 5.4% in the 12 months to March, the fastest rise since April 1983.

The Fed is “ready to take stronger action when inflation indicators and inflation expectations suggest such action is warranted,” Federal Reserve Governor Lael Brainard said on Tuesday.

According to Investing.com, about 80% of traders expect the Fed to hike rates by 50 basis points at its May meeting

Rate hikes are not the only tool in the Fed’s monetary policy toolbox. The Fed can also shrink its nearly $9 trillion balance sheet, a move Powell hinted last month “could amount to another rate hike.”

However, history proves that balance sheet shrinking or quantitative tightening is no easy task.

In 2018, the Fed allowed certain bonds to expire each month without reinvesting the bonds’ principal, mostly U.S. Treasuries and mortgage-backed securities, in new securities.

The Fed opted for a phased and limited approach, allowing about $10 billion worth of securities per month — $6 billion per month in Treasuries and $4 billion per month in mortgage-backed securities — to fund its Reduce balance sheet to gradually speed up the process.

But as the pace of outflow reached $50 billion a month, the central bank was forced to halt the process in late 2019 after a key short-term overnight lending rate that supports financial system stability surged, risking stability financing markets.

Powell, pointing to the strength of the economy, believes this time is different.

The wave of aggressive rhetoric from Fed members has not gone unnoticed. The bond market appears to be pricing in the growing risk that the US Federal Reserve will overshoot on tightening and over-constrain the economy, ultimately leading to a recession.

A key part of the yield curve, the 2+ year Treasury yield, briefly inverted recently, a warning sign that a recession may 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 as the Fed is expected 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 additional tightening by the Fed by late next year and early 2024,” said Deutsche Bank economists David Folkerts-Landau and Peter Hooper in a report dated Tuesday.

https://www.investing.com/news/economy/fed-members-eye-larger-rate-hikes-balance-sheet-reduction-minutes-2799297 Fed Members See Major Rate Hikes, Balance Sheet Trimming: Minutes from Investing.com

Chris Barrese

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