May 20, 2022
U.S. Federal Reserve

The Fed has been signaling a speedy rundown of its balance sheet by raising interest rates, but it backed off from an even larger increase this month due to the unrest in Ukraine. Fed officials noted signs of rapid inflation, including big increases in wages and input costs. They noted there is no sign of any significant slowdown in demand, but they were also wary of supply chain disruptions.

The rundown is being pushed forward because the Fed is losing between $80 billion and $100 billion per month to rising interest rates. These assets are home mortgages, bonds and other longer-term debt. Market reaction may be muted, but the plan is likely to send a strong signal to the credit markets and help control inflation. So far, the market has not expressed much concern about the move.

The next meeting of Fed officials will provide more details about the pace of this rundown. They will likely limit the amount of securities they reinvest each month to $60 billion for Treasury securities and $35 billion for mortgage-backed securities. This amount will be double the rate of shrinking seen in the past three years. The Fed also discussed the speed of interest rate hikes. While this plan is a bit ambitious, it still has plenty of time to make it work.

This move is a signal that the Fed is becoming more confident in the economy. It wants to respond to inflation that is running 2 percent above their target. Moreover, the labor market has been showing signs of improvement, and the Fed believes that full employment is within reach. But there is still a long way to go. And the balance sheet rundown is still far from complete.

While Jerome Powell and other Fed officials have outlined a plan for a speedy balance sheet rundown, most analysts expect a much smaller amount. They’ve discussed the rundown since last autumn. Powell has flagged a slower pace of balance sheet shrinkage to Congress, and Williams has said that the Fed should operate in a predictable manner. And most importantly, they are doing this in small amounts.

Although Fed officials are concerned about the high levels of inflation, they are also concerned about rising prices and expectations. This could make price control more difficult. Janet Brainard said the balance sheet rundown could happen quickly, but the market didn’t react well to the news. Janet Lacker’s comments and statements were also a major reason why investors were looking at the minutes of the Fed.

While Powell’s remarks may seem extreme, the underlying debate remains the same. The Federal Reserve’s March meeting minutes may help traders understand the Fed’s debate and determine which path they should take. Traders in federal funds futures contracts anticipate that the Fed will use half-point increases at three more meetings this year, which would be the fastest tightening cycle since the Sixties.