FOMC minutes: The Fed’s balance-sheet rundown looks like ending soon

The minutes of the FOMC meeting held on 29th /30th January which were published yesterday reveal that committee members are not yet prepared to proclaim that the Fed’s rate-hike cycle is at an end. For example, a number of members of the Fed’s policymaking body have gone on record as saying that further tightening may perhaps be necessary over the course of the year, making this contingent on how the economic situation develops. The transcript shows, however, that almost all FOMC members are in agreement, in view of the growing risks, that a temporary pause in the rate-hiking cycle would be appropriate. They argue that there is currently a whole cluster of risks which, in their view, indubitably justify an interruption in the tightening cycle. Factors imposing a particular burden are the difficult Brexit negotiations, the trade dispute between the United States and China, the volatile equity-market trend and the five-week partial shutdown of federal agencies. The minutes see these factors as having the potential to adversely affect economic momentum in the United States, China and Europe alike. At the same time, the Fed has acknowledged that market participants already failed to understand the logic behind December’s key-rate hike against a background of tightening financing conditions. As to the topic of balance-sheet unwind, the various FOMC members pointed out that they are expecting the Fed to end balance-sheet runoff towards the end of the year.

In our opinion, the announcement that the Fed may stop reducing its asset holdings should not be construed as a monetary-policy easing measure. In the first instance, halting balance-sheet shrinkage would probably be a technical measure aimed at limiting money market rate volatility. In our view, the desire of US commercial banks to hold a higher volume of excess reserves with the Fed on account of regulatory requirements does indeed make it necessary for the Federal Reserve to stop shrinking its balance sheet over the course of the year. We are sceptical, however, about whether the Fed will adhere to this measure right through until year-end 2019; we are more expecting an announcement that balance-sheet reduction is to be suspended to come through in the autumn. Furthermore, there are now indications that the Fed will subject its rate-hike projections (currently two tightening steps during 2019) to a revision in March. We are sceptical, though, whether the Fed will raise the fed funds target rate at all over the course of the present year. The pause which has been mooted would be thoroughly warranted in view of the numerous political risks which are looming. Even if the existing flashpoints will presumably not ignite an outright conflagration, they are likely to carry on smouldering. In such an environment, the Fed is hardly going to tighten the monetary reins any further.

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