U.S. Fed may be open to changes to balance sheet plan, minutes show

By Ann Saphir

SAN FRANCISCO (Reuters) – Federal Reserve policymakers have indicated they may be open to tweaking a longstanding plan to shrink the central bank’s balance sheet, including by shedding housing-backed bonds earlier than anticipated or keeping a bigger-than-expected portfolio of assets.

Those were among a range of options discussed at the Fed’s December meeting, minutes released on Wednesday showed. The discussion will continue at future meetings, the minutes said.

JP Morgan chief U.S. economist Michael Feroli, writing in a note to investors, described the debate as informal “spitballing.” Fed Chair Jerome Powell himself said in December that shrinking the balance sheet was on “automatic pilot.”

But the discussion shows that the future of the plan may be in flux as policymakers become increasingly nervous about potential kinks in their control over short-term interest rates.

The Fed for years bought bonds to stimulate a moribund economy, eventually accumulating a $4.5 trillion balance sheet, but began reversing course in 2013, first by slowing its bond-purchases and then, in 2017, allowing the portfolio to shrink.

The Fed is now trimming its holdings by $50 billion each month, an amount intended to reduce the portfolio to a more “normal” size over a number of years without putting too much pressure on the Fed’s short-term policy rate.

It has now shed more than $380 billion worth of U.S. Treasuries and mortgage bonds. But reserves are declining at a much faster rate, dropping to $1.51 trillion at the end of 2018, from a 2014 peak of more than $2.7 trillion.

If reserves become too scarce, demand for them could push the Fed’s key policy rate above its target band, now set at 2.25 percent to 2.5 percent. The Fed has already made a couple of technical adjustments to keep that from happening, and the minutes show policymakers may do so again.

Policymakers also discussed other options to maintain control of rates, including the possibility of holding a larger “buffer” of securities, or slowing the pace of decline in reserves as they approach the desired longer-run level.

Several participants, though, worried that changes to the balance sheet runoff might be “misinterpreted as a signal about the stance of monetary policy.”

Policymakers also raised the possibility of shedding mortgage-backed securities “more quickly” than the current plan, which does not anticipate any MBS sales.

“We have been expecting, and continue to expect, the Fed to opt in favor of continuity and predictability by sticking with the current normalization principles and plans,” JP Morgan’s Feroli said of the balance sheet discussion, “but we concede that this aspect of the longer-run Fed outlook is now less certain.”

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