Fed officials concluded at their January meeting that inflation was too high as the economy entered full employment, warranting an imminent rise in the benchmark interest rate. Rising inflation has prompted some US central bankers to revise their outlook for rate increases this year.
The prominent facts in the minutes regarding the principles of rate hike, policy tightening and balance sheet reduction;
· Most respondents indicated that if inflation did not decline as they expected, it would be appropriate for the Committee to adjust policy more quickly than they currently anticipate. (Definite rate hike in March)
· The Committee sees changes in the federal funds rate target range as the primary means of adjusting the monetary policy stance.
· The Committee will determine the timing and pace of the Fed’s downsizing of its balance sheet to support maximum employment and price stability goals. The committee hopes that shrinking the size of the Fed’s balance sheet will begin once the process of increasing the federal funds rate target range begins. (Details of the balance sheet shrinkage will likely come out in March, it looks like it’s appropriate to start the mid-year shrinkage.)
· The Committee aims to reduce the Fed’s securities holdings in a predictable way over time, primarily by adjusting the reinvested amounts of principal payments received from securities held in the System Open Market Account (SOMA).
· Over time, the Committee aims to hold securities in the quantities necessary to implement monetary policy efficiently and effectively in a plentiful reserve regime.
· Over the longer term, the Committee aims primarily to hold Treasury securities in SOMA, thereby minimizing the impact of Fed assets on credit allocation across sectors of the economy.
· The Committee is ready to change any detail of the balance sheet reduction approach in light of economic and financial developments.
Fed futures funds rate pricing… Source: Bloomberg, CME Fedwatch
While current data continues to show a hot economy experiencing the highest inflation in 40 years, investors are seeing a tightening of at least 150 basis points in 2022 from 75 basis points a few weeks ago. A move is fully priced in the markets at the FOMC’s next meeting on March 15-16, with officials predicting it could raise rates by up to 50 basis points. Data since policymakers met a few weeks ago reinforced that message, with consumer price growth hitting a four-year high of 7.5% in January. In the labor market, the US added almost half a million new jobs last month and wages soared, despite record Covid-19 cases. On the other hand, wages are still negative in real terms, and American citizens have been in a tighter situation recently, especially on the side of food and gasoline expenditures, in an environment where government pandemic incentive packages have also been withdrawn.
Although the first rate hike of 25 basis points is still ideal for a more preferable smooth transition for the Fed and the market, concerns about rising inflation give enough reason to exceed this limit. Apart from that, MBS can be sold from portfolios in addition to Treasury bonds for the Fed’s balance sheet reduction, which is actually a possible step to complete a rapid contraction. The Fed did not have to cope with such a high inflation while shrinking the balance sheet since 2017, and there is a big difference between shrinking the balance sheet from 4 trillion dollars to 9 trillion dollars. The excess liquidity revealed by the pandemic is likely to warm the situation, and if the Fed does not tighten its balance sheet quickly, it will still appear to give incentives to the economy. As we have taken the rate hike phenomenon for granted, we need to take a deeper look at the balance sheet details at the March meeting. The minutes do not reveal any new concerns.
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