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Checking the Gauges as Policy Tightening Is About to Accelerate
By: Edward Jones
Fed minutes confirm an aggressive tightening plan ahead
The minutes offered clues about 1) the pace of future interest-rate hikes, and 2) the shrinking of the Fed's almost $9 trillion bond holdings, a process also known as balance-sheet normalization, or quantitative tightening.
1) Fed officials signaled that they could move more rapidly on policy, noting that one or more half-point increases in the policy rate could be appropriate at future meetings. For perspective, the Fed hasn't raised rates by a half-point since 20001. With headline inflation likely to exceed 8% in April, unemployment at 3.6%, and the bond market already pricing in a 0.5% hike for the May and June meetings, we think that policymakers will choose to speed up the move towards a more neutral policy stance with one or potentially two supersized rate hikes1.
2) The minutes revealed for the first time how the Fed expects to shrink its asset holdings, which along with rate hikes would serve as another tool for tightening monetary policy. By allowing up to $95 billion in bonds ($60 billion in Treasuries and $35 billion in mortgage bonds) to mature every month without being replaced, the Fed will be withdrawing cash from the financial system, further applying upward pressure on long-term yields.
The 2017 – 2019 experience offers mixed takeaways
The last time the Fed attempted to shrink its asset portfolio was between 2017 and 2019. At that time the balance-sheet reduction, which ran at a pace of $50 billion a month, didn't start until a year after the first rate hike, and the Fed continued to hike rates until late 2018 before reversing course and bringing the hiking cycle to an end. The effect on the stock and bond market was mixed as it evolved with the progression of the Fed tightening.
We think that the 2017 - 2019 experience provides a decent blueprint for how the concurrent Fed hikes and balance-sheet reduction could impact markets. However, it is not a perfect historical precedent because today's stronger economic growth, looser policy and higher inflation make for a unique backdrop.
Source: 1. Bloomberg
Edward Jones - Mae Luchetti