Fed Minutes Reveal Discussions About Accelerated Balance Sheet Reduction

Members of the Federal Reserve are preparing to begin reducing the size of the central bank’s balance sheet soon after raising interest rates, the minutes of the latest Federal Open Market Committee meeting revealed.

The minutes of the December 14-15 meeting, released on Wednesday, showed participants had initial discussions about the appropriate conditions and timing for reducing the Fed’s approximately $8.8 trillion portfolio of Treasury and mortgage securities.

While the previous balance sheet runoff commenced almost two years after policy rate liftoff, participants judge that the appropriate timing this time around would likely be closer to that of policy rate liftoff.

“They noted that current conditions included a stronger economic outlook, higher inflation, and a larger balance sheet and thus could warrant a potentially faster pace of policy rate normalization,” the minutes said.

The minutes noted many participants also judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode.

The discussions about reducing the size of the central bank’s balance sheet came as the Fed also agreed to accelerate the pace of reductions to its asset purchases, with the program currently slated to come to an end in mid-March.

Many economists expect the Fed to begin raising interest rates as soon as the asset program ends, with CME’s FedWatch Tool currently indicating a 71.0 percent chance of a rate hike at the March 15-16 meeting.

The minutes noted that participants generally agreed it may be warranted to raise rates sooner or at a faster pace previously anticipated given the outlook for the economy, the labor market, and inflation.

“Some participants judged that a less accommodative future stance of policy would likely be warranted and that the Committee should convey a strong commitment to address elevated inflation pressures,” the minutes said.

The Fed added, “These participants noted, however, that a measured approach to tightening policy would help enable the Committee to assess incoming data and be in position to react to the full range of plausible economic outcomes.”

Commenting on the minutes, Paul Ashworth, Chief U.S. Economist at Capital Economics, said it makes sense that quantitative tightening should be more rapid this time around, as the balance sheet is much larger than the previous peak and economic conditions much stronger.

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