Discussion about the Federal Reserve’s evolving balance sheet policy will steal the spotlight Wednesday when the U.S. central bank releases the minutes of its March policy meeting.
Because a number of Fed officials have commented on balance sheet policy, the minutes “may be even more closely watched than is usually the case,” said Omair Sharif, senior U.S. economist at Societe Generale.
The balance sheet is the “white elephant in the china room,” said Chris Flanagan, an economist at Bank of America, in an interview, using the European version of the American idiom.
Minutes of the meeting will be released on Wednesday at 2 p.m. Eastern
Reducing the balance sheet could be “upsetting” for markets if not handled right, he said. Tightening of policy has always been upsetting and this time is likely to be no different, Flanagan said.
Starting in late 2008, the Fed amassed $4.5 trillion in Treasurys and mortgage-related securities in the aftermath of the financial crisis, in an effort to keep long-term interest rates low and help spur activity. Reducing the balance sheet is expected to push up long-term rates.
“It’s a pretty big deal. They haven’t spoken about it yet,” Flanagan said.
The Fed hiked rates at its March 14-15 meeting for the second time in three months and penciled in two more rate hikes for the year. The meeting also included a discussion of the balance sheet, Fed Chairwoman Janet Yellen said.
“We made no decisions and will continue our discussion at subsequent meetings,” Yellen said during her press conference.
Any clues on the timing of the shrinking of the balance sheet is the most important issue from market participants viewpoint, said Sharif.
New York Fed President William Dudley last week said the shrinking the balance sheet, by ending reinvestment of maturing principal, could start “sometime later this year.” Other Fed officials have also signaled an openness for starting to shrink the balance sheet this year.
That’s sooner than the market expected three months ago, according to the median expectation in the New York Fed’s Primary Dealers Survey . Dealers thought a change in balance sheet policy would begin around mid-2018.
Andrew Hollenhorst, an economist at Citigroup, said a significant discussion of the nuts and bolts of reducing the balance sheet, combined with signals the process could begin this year, would be seen as “very hawkish” by the market.
Less hawkish would be “some” officials arguing to start shrinking the balance sheet this year with minimal discussion of the details, he said.
The market is also looking to see if other officials hold Dudley’s view about pausing rates for some time one the balance sheet shrinking begins, Sharif added.
Read: Lost in the balance sheet debate —the Fed may pause rate hikes one run-off begins
Lewis Alexander, chief U.S. economist at Nomura, said clearly a debate over the balance sheet was still going on internally.
“The Fed is perhaps beyond the early days of the discussion but it doesn’t feel to me that the Fed is converging” on a plan, he said.
“I’d be surprised if the minutes said, ‘here is the answer,’” Alexander added, in an interview.
Kevin Cummings, senior economist at Natwest Markets, said he expects the Fed to release revised “exit principles” in either May or June. This road map was last updated in September 2014.
Although the balance sheet would steal most of the thunder, analysts say they were also paying attention to whether there are any deviations from the Fed’s “base case” of three rate hikes in 2017 and whether the committee is predisposed to acting again in June.