Federal Reserve officials discussed how they want to reduce their trillions in bond holdings at the March meeting by a consensus of about $ 95 billion a month, minutes released Wednesday showed.
Officials “generally agreed” that a maximum of $ 60 billion in government bonds and $ 35 billion in mortgage-backed securities would be allowed to roll out, phased in over three months and likely from May. The total amount would be about double the last effort, from 2017-19, and represent part of a historic shift from ultra-easy monetary policy.
In addition to the balance talk, officials also discussed the pace of interest rate hikes ahead, with members leaning towards more aggressive moves.
At the meeting on 15-16. March, the Fed approved its first rate hike in more than three years. The increase of 25 basis points – a quarter of a percentage point – lifted the leading short-term borrowing rate from the level of almost zero, where it had been since March 2020.
However, the minutes pointed to potential interest rate hikes of 50 basis points at forthcoming meetings, a level in line with market prices for the May vote. In fact, there was a significant mood to rise last month. Uncertainty about the war in Ukraine discouraged some officials from going with a move of 50 basis points in March.
“Many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, especially if inflationary pressures remain increased or intensified,” the minutes read.
Shares fell after the Fed announcement, while government bond yields remained higher. However, the market recovered well from the low level as traders adapted to the central bank’s new stance.
The minutes were “a warning to anyone who thinks the Fed will be more dove-like in their fight against inflation,” said Quincy Krosby, chief equity strategist at LPL Financial. “Their message is, ‘You are wrong.'”
In fact, in recent days, policy makers have become increasingly stern in their view of taming inflation.
Governor Lael Brainard said Tuesday that getting prices down will require a combination of steady increases plus aggressive balance sheet reduction. Markets expect the Fed to raise interest rates by a total of 250 basis points this year. The minutes noted that “All participants expressed their strong commitment and willingness to take the necessary steps to restore price stability.”
Krosby said that the politicians’ position should therefore not have come as much of a surprise.
“The Fed orchestrated a concerted effort to warn the market and told the market in clear terms that this is serious, it’s crucial, we want to fight inflation,” she said. “What they have on their side is a still healthy job market, and that’s important. What you do not want is for the Fed to make a political mistake.”
The central bank’s relative hawkishness extended to the balance talk. Some members wanted no ceilings for the amount of monthly runoff, while others said they were good with “relatively high” limits.
The balance sheet will show that the Fed allows a limited level of proceeds from the maturity of securities to roll out each month while the rest is reinvested. Holdings of short-term treasury bills will be targeted as they are “highly valued as safe and liquid assets by the private sector.”
While officials did not conduct any formal voting, the minutes indicated that members agreed that the process could begin in May.
Whether the runoff will actually hit $ 95 billion, however, is still in doubt. MBS demand is now subdued with low refinancing activity and mortgage rates rising above 5% for a 30-year loan. Officials acknowledged that passive mortgage repayments are unlikely to suffice, with direct sales to be considered “after balance sheet repayments were well underway.”
Also at the meeting, Fed officials raised their inflation outlook sharply and lowered their expectations for economic growth. Rising inflation is the driving factor behind the central bank’s tightening.
The markets looked at the minutes release for details on where monetary policy is heading from here. Specifically, Fed Chairman Jerome Powell said at his news conference after the meeting that the minutes would provide details on the thoughts around balance reduction.
The Fed expanded its holdings to about $ 9 trillion, or more than double, during monthly bond purchases in the wake of the pandemic crisis. These purchases ended just a month ago, despite evidence of roaring inflation higher than anything the U.S. had seen since the early 1980s, an increase that then-Fed chairman Paul Volcker dampened by pulling economy into a recession.