Fed won’t re­duce bond book this year, Yellen sig­nals

The Star Late Edition - - COMPANIES - Bloomberg

US FED­ERAL Re­serve chair Janet Yellen set a rel­a­tively high hur­dle for shrink­ing the cen­tral bank’s bal­ance sheet, lead­ing some an­a­lysts to con­clude that such a move won’t oc­cur this year.

She told the Se­nate Bank­ing Com­mit­tee on Tues­day that the Fed’s fo­cus was on rais­ing in­ter­est rates to keep the econ­omy in bal­ance, not on re­duc­ing its hold­ings of bonds.

Rates first had to reach suf­fi­ciently high lev­els be­fore the Fed felt it had some room to cut them to off­set a weakening econ­omy. Only then would the cen­tral bank be­gin to shrink its $4.5 tril­lion (R58.7tn) bal­ance sheet, she said.

“What we would like to do is to find a time when we judge that our need to pro­vide sub­stan­tial ac­com­mo­da­tion to the econ­omy in the com­ing years is min­i­mal,” she said.

The cen­tral bank also wanted to be sure “that the econ­omy is on a solid course and the fed­eral funds rate has reached lev­els where we have some abil­ity to ad­dress weak­ness by cut­ting it”, she added.

Ward McCarthy, the chief fi­nan­cial econ­o­mist for Jef­feries LLC in New York, said this meant there would not be a move to start shrink­ing the bal­ance sheet this year.

Pol­i­cy­mak­ers ex­pect to in­crease the Fed funds rate to 1.4 per­cent by the end of this year, ac­cord­ing to the me­dian of their pro­jec­tions re­leased on De­cem­ber 14. That would still leave it be­low the 20-year av­er­age of 2.3 per­cent.

The tim­ing and scope of any moves to re­duce the Fed’s debt hold­ings could have big im­pli­ca­tions for the bond mar­ket and for the econ­omy as a whole. That’s be­cause, as Yellen her­self noted, they would rep­re­sent an ef­fec­tive tight­en­ing of mon­e­tary pol­icy. “Al­low­ing that process to take place,” Yellen said, “will show that the econ­omy is do­ing well.”

The pol­icy-set­ting Fed­eral Open Mar­ket Com­mit­tee (FOMC) has said it will con­tinue to rein­vest prin­ci­pal pay­ments on the ma­tur­ing bonds in its port­fo­lio un­til “nor­mal­i­sa­tion of the level of the fed­eral funds rate is well un­der way”. The Fed chair said the re­duc­tion in the Fed’s bond port­fo­lio would oc­cur in a “grad­ual and or­derly way”.

Yellen told the law­mak­ers on Tues­day that the FOMC would dis­cuss that strat­egy “in the com­ing months” with the aim of pro­vid­ing in­vestors with “some fur­ther guid­ance” about its in­ten­tions.

The cen­tral bank would want to tele­graph its plans well in ad­vance of their im­ple­men­ta­tion, to avoid up­set­ting fi­nan­cial mar­kets, Michael Feroli, the chief US econ­o­mist at JP­Mor­gan Chase in New York, said.

He ex­pects pol­i­cy­mak­ers to do that in the sec­ond half of this year. How­ever, the process of halt­ing rein­vest­ments will not be­gin un­til the mid­dle of next year, ac­cord­ing to Feroli.

Yellen re­jected re­cent sug­ges­tions by sev­eral Fed bank pres­i­dents that the cen­tral bank use its bal­ance sheet as an ac­tive tool of mon­e­tary pol­icy. In­stead, the fo­cus will re­main on man­ag­ing the Fed funds rate in re­sponse to changes in the econ­omy.

The Fed chair also said the re­duc­tion in the Fed’s bond port­fo­lio would oc­cur in a “grad­ual and or­derly way”. That’s sim­i­lar to the strat­egy the cen­tral bank em­ployed when it ta­pered its as­set pur­chases in 2014, re­duc­ing them in set amounts at each pol­i­cy­mak­ing meet­ing.

More than $600 bil­lion (R7.8tn) in Trea­sury se­cu­ri­ties in the Fed’s port­fo­lio are sched­uled to ma­ture this year and next, ac­cord­ing to cal­cu­la­tions by Bloomberg.

McCarthy said the next Fed chair might well take a more ag­gres­sive approach to re­duc­ing the bal­ance sheet, although Feroli said it might be dif­fi­cult to change the Fed’s strat­egy once it has been put into place and di­gested by the mar­kets.

Yellen told law­mak­ers that she ex­pects the cen­tral bank to even­tu­ally end up with “a bal­ance sheet that’s sub­stan­tially smaller than at the cur­rent time”.

“In ad­di­tion, we would like our bal­ance sheet to again be pri­mar­ily Trea­sury se­cu­ri­ties,” she said. Be­sides Trea­suries, the Fed port­fo­lio also con­tains mort­gage-backed debt and agency se­cu­ri­ties is­sued by Fan­nie Mae and Fred­die Mac.

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