The Federal Reserve is looking to reduce its $4.5 trillion stockpile of government- and mortgage-backed bonds later this year, according to minutes of the March policy meeting released Wednesday.
The plan to reduce the balance sheet size is tied to interest rates increasing, the minutes reveal. In their discussion of the path of interest rates, officials supported a gradual pace of rate hikes but said they could change their mind if the economy unexpectedly heated up.
See highlights of the Fed minutes
“We read the minutes from the March FOMC as slightly hawkish – mainly regarding the timing of balance sheet reduction,” said Andrew Hollenhorst, economist at Citigroup.
“We maintain our call for two further hikes this year with balance sheet reduction announced in December,” he said.
lost all of their earlier gains and closed in negative territory after the release of the minutes, and the yields on government bonds
The first step in shrinking the balance sheet would be to end reinvestment of principal of maturing Treasurys and mortgage-related assets. The minutes point to at least some slowing in the reinvestment later this year. While there was some talk of stopping reinvestment all at once, the weight of the discussion seemed to point to officials favoring a gradual slowing of reinvestment, if the economy performs as the central bank expects.
Officials said they would signal the policy change well in advance.
The minutes reveal that central bank officials had an in-depth discussion of the technical details of the balance sheet policy, including whether to phase out reinvestment of principal payments or do it all at once. Fed watchers were not expected such a granular discussion at the meeting, thinking it would wait until the May or June meeting. Actively selling assets is still years away, said Paul Ashworth, chief U.S. economist at Capital Economics.
There was no mention of New York Fed President William Dudley’s comments that slowing the pace of reinvestment would be a substitute for raising short-term interest rates.
Read: Lost in the balance sheet debate — the Fed may pause rate hikes once run-off begins
In their discussion of the economy, the minutes show “several” of the hawks urged the Fed to raise rates at a faster pace since the central bank was on the cusp of meeting its 2% inflation goal. These officials feel there is no slack left in the labor market.
If the unemployment rate falls below the “natural rate” of unemployment, this “posed a significant upside risk of inflation,” according to the hawks.
On the other hand, several dovish Fed officials saw “limited risk of a marked pickup in inflation as the labor market tightened further” given the sluggish behavior of inflation in recent years and also the fact that business and consumer expectation of higher prices are well anchored.
The 10 voting members of the Fed’s policy committee seem more dovish than the full 17 members who get a voice at the meeting. Voters said they expected headline inflation might rise a bit above the 2% target in the near term, but only temporarily.
There also was a lengthy discussion of the stock market, which some Fed officials described as “quite high” by standard valuation measures. Financial conditions were seen as a doubled-edged sword, either potentially providing greater stimulus from consumer spending or downside risks from a significant correction.
While Fed officials were prepared for a weak first-quarter GDP reading, they believed any slowdown in the first quarter was temporary.
The central bankers also now expect President Donald Trump’s plans for expansionary fiscal policy would likely not begin until 2018.