Expect Little Change in FOMC's Balance Sheet Plans Next Week
posted by Michael Lewis on January 25, 2019 - 12:00am
This morning, the Wall Street Journal issued a "bombshell" report about changes to the Fed's plans to "normalize" its balance sheet. The story, FMI contends, delivered far less than it promised.
The WSJ reported, in an overwrought and very run-on opening sentence, that “Federal Reserve officials are close to deciding they will maintain a larger portfolio of Treasury securities than they’d expected when they began shrinking those holdings two years ago, putting an end to the central bank’s portfolio wind-down closer into sight.”
In fact, as the rest of the story made clear, there is no Fed consensus on what the “final” balance sheet should look like nor on when that level would or should be achieved.
Here is what we do know:
To date, the balance sheet is down from more than $4.2 trillion in late 2017 to $3.8 trillion (vs. only $0.5 trillion before the Great Recession). The original program to taper off the rollover of maturing assets was intended to run for several more years.
When announcing the program, Janet Yellen and other officials said it would be akin to “watching paint dry” and have no significant effect on the economy or financial markets.
The FOMC appears unanimous in believing that the balance sheet should shrink much further. Publicly, various Fed officials have discussed estimates for the “final” balance sheet ranging from $1 trillion to $3 trillion, down from the current $3.8 trillion. Chairman Powell has said that the balance sheet would not return to pre-recession levels because of greater global demand for U.S. currency.
Not a single FOMC member, not even the most dovish, has advocated increasing the balance sheet through another round of QE.
Chairman Powell has declared that he does not believe the balance sheet changes are “a major culprit” behind the stock market correction, but he promised the Fed would make adjustments if that assessment changed.
So what will happen when the FOMC meets next week:
The post-meeting statement will not mention the balance sheet at all. The statement, which FMI has argued is the single best distillation of the Fed’s priorities, has not referenced the balance sheet in more than a year. Nuances in the balance sheet are simply not that important.
The implementation note, which the FOMC has been appending to its statement release, does include details on the balance sheet. This technical detail is far less important than the statement itself. Most likely, the note will show that the drawdown will remain $50B per month ($30B in treasuries, $20B in MBS).
Starting this week, Powell will conduct a news conference after every FOMC meeting, not just the once-a-quarter meetings where the FOMC updates its “dot plot.”
Powell will almost certainly repeat his comments that the balance sheet drawdown is not hurting the financial markets, but he will reiterate that the Fed will make adjustments if needed. Essentially, this will be an exercise in hand-holding for the twitchy equities markets and some twitchy analysts. His remarks will be widely perceived as dovish, but they will not change policy.
The FOMC will remain committed to gradual rate hikes and gradual normalization of the balance sheet unless and until the macro data demand otherwise. That is, the FOMC will remain data-dependent.