Economists say fallout from Fed balance sheet reduction would be minimal

May 15, 2017

Keywords: Client Focus

With each passing Federal Open Market Committee meeting, debate ensues in economist circles regarding whether the Federal Reserve will keep conditions the same or raise rates, which it's decided to do on three separate occasions since December 2015. More are expected in the coming months, the next one perhaps as soon as June. Its decision - be it for or against - is swayed by market conditions, but the ultimate aim is to keep the economy as healthy as possible.

Lost in the shuffle is what the Fed plans to do with its portfolio of bonds. Currently valued at $4.5 trillion, economist largely believe that the central bank will taper its portfolio, doing so to further support the economy's well-being. Should it indeed opt to shrink its balance sheet, however, economists think that the impact on monetary policy and rates will be modest at best, according to The Wall Street Journal.

Approximately 55 percent of economists polled by the Journal think the Fed shedding its balance sheet by letting assets mature will raise the yield on 10-year Treasury notes no more than 0.2 percentage points. Meanwhile, 40 percent though the impact would be virtually negligible, the yield up 0.1 percent or less.

Little to no impact on monetary policy
Similarly, as to what impact a balance sheet reduction would have on monetary policy, economists think it will be nominal. Specifically, roughly 50 percent said it would have less of an impact than would raising key interest rates another quarter-percent, which the Fed is expected to do in June. An additional 20 percent didn't think the move would have any meaningful effect.

Though the Federal Open Market Committee is loath to reveal its hand, members of the board of governors have given intimations that it wants to begin the balance sheet reduction process soon, so as to thwart any major disturbances to the global economy, the Journal reported. Officials worry that starting too late could result in so-called "taper tantrum," pointing to 2013 as the last time something similar happened that resulted in market instability.

Stanley Fischer, the Fed's vice chairman, says because the economy is in much better shape, a repeat of 2013 is highly doubtful.

"We appear less likely to face major market disturbances now than we did in the case of the taper tantrum," Fischer told the Journal in April. Fischer noted further the Fed will make its intentions unambiguous to ward off market fluctuations.

Fed officials talking up a storm
Communication is something that the Fed has been doing much more as of late, especially for an organization that historically has kept things close to the chest.  An economist told CNBC's "Trading Nation" that the more talkative trend traces back to the mid-1990s, to the point where this year, FOMC committee members are expected to deliver 14 speeches per member. That's up from four each in 1996. The Board of Governors is composed of seven members, one of which is the president of the Federal Reserve Bank of New York.

Here at Miles Capital, communication is our specialty, offering trusted, integrated guidance that is client focused and results driven.

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