Analysts Sceptical Fed Can Pull Off Tapering While Hiking Rates

Most Federal Reserve officials agree that they will begin shrinking their super-sized balance sheet later this year. What they don’t want to discuss in detail yet is how that will shape their plans to continue raising the short-term interest rate in 2018.

The minutes of the March meeting employed some key words to outline plans to trim the balance sheet, which ballooned to $4.5 trillion following three rounds of bond purchases. Reductions need to be “gradual and predictable,” and should be accomplished by “phasing out” of reinvestments, meaning the central bank wouldn’t abruptly stop repurchasing all debt instruments when they mature. Finally, policy makers indicated reductions would start “later this year,” although they didn’t provide details on amounts.

The critical line the Fed is trying to walk is one of slow balance-sheet shrinkage that doesn’t tighten financial conditions so much that it becomes a second tool of monetary policy. Most Fed officials want the federal funds rate to be the primary instrument, according to the minutes published on Wednesday. That may be little more than wishful thinking.

“I am highly skeptical” the balance-sheet strategy won’t impact monetary policy, said Laura Rosner, senior U.S. economist at BNP Paribas in New York. “It is hard to imagine that this isn’t going to lead to significant tightening.”

via Bloomberg

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