Published: Thu, April 06, 2017
Markets | By Lucia Cruz

US Fed set to shrink balance sheet

The minutes of the March meeting showed that Fed officials are keeping a closer watch on inflation but don't yet believe it is meeting their 2 percent target on a sustained basis.

The minutes showed that Fed officials received a staff briefing on managing its $4.5 trillion bond portfolio.

In the wake of the Great Recession, the Fed began making massive purchases of government bonds and mortgage-backed securities, raising the demand for, and therefore the price of, those assets, and lowering their interest rates in the process.

"Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal..."

"The FOMC minutes were clear that officials are contemplating beginning to address the balance sheet", said Win Thin, an economist at Brown Brothers Harriman.

Capital Economics' chief U.S. economist Paul Ashworth said upside risks in the minutes now outweighed downside ones, suggesting there could be a fourth rate rise this year. One meeting participant, the minutes noted, called for a "rapid" drawdown in the size of the Fed's assets, starting with mortgage-backed securities-the once fatefully-overpriced, complex assets whose values dropped precipitously during the 2007 housing market crash. The Fed has been reinvesting those maturing bonds to keep from shrinking its holdings and thereby exerting upward pressure on long-term rates. It added that any decisions should be conveyed to markets before being implemented.

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The Fed's next policy meeting is scheduled for May 2-3 while investors now expect another rate rise in June.

The minutes from the Fed's March meeting showed continued uncertainty about how the White House's policies would affect the economy, with only about half of the Fed's voting members incorporating assumptions about fiscal policy into their economic projections.

The rate increase the Fed announced last month was its second in three months.

The minutes also showed some disagreement over the near-term dangers of inflation, a subject that had divided Fed members in mid-2016.

However, Fed officials underscored the considerable uncertainty about the timing and nature of potential changes to fiscal policies as well as the effects of such changes on the economic activity. The Fed's two goals are to achieve maximum employment and moderate inflation.

If the measures do come later this year, it's possible the Fed would have to raise rates more quickly to offset inflation. Others argued that since inflation had run below 2 per cent for so long, it would do no harm to allow prices to rise above 2 per cent for a time. But with Wednesday's release of minutes from the mid-March meeting of the central bank's policy-making arm, attention shifted to another instrument in the Fed's toolbox.

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