Quantitative tightening, which Federal Reserve chair Jerome Powell likes to refer to as “balance sheet runoff,” is no longer on autopilot.
Markets plunged in December when Powell blithely talked about robust growth and additional interest rate increases in 2019, and casually mentioned that shrinking the Fed’s balance sheet to the tune of $50 billion a month seems to be working fine on autopilot.
Since then, the Fed has famously reversed course by 180 degrees. First, it effectively ruled out any rate increases this year. Now the message coming across is that the Fed won’t be shrinking its balance sheet much more than it has already and will keep it at fairly elevated levels. It may even keep quantitative easing—purchasing bonds with money created out of thin air—as a new tool for monetary policy rather than just an emergency measure.
Fed Governor Lael Brainard, the only remaining member of the board of governors who has not been appointed or reappointed by President Donald Trump, said QT may already end this year. “My own view is that balance sheet normalization process should probably come to an end later this year,” she said in an interview with CNBC.
She noted that Powell had already said the Fed aims to keep an ample supply of bank reserves. These have declined 40 percent from their peak, she said, so “the balance sheet normalization process has really done the work it was supposed to do.”
Bank reserves currently are about $1.6 trillion, well above pre-crisis levels, on a balance sheet total just over $4 trillion. Powell dwelt at some length in his January press conference on banks’ need for “ample” reserves and what that meant for Fed balance sheet policy.
“Higher reserve holdings are an important part of the stronger liquidity position that financial institutions must now hold,” he said in his opening statement. “The implication is that the normalization of the size of the portfolio will be completed sooner, and with a larger balance sheet, than in previous estimates.”
It’s a fair bet that a similar message will be coming from Cleveland Fed chief Loretta Mester when she speaks in Delaware later today [Tuesday] and will be in the minutes of the January meeting released tomorrow [Wednesday]. James Bullard, president of the St. Louis Fed, will be taking part in a panel discussion Friday at the University of Chicago devoted to the question of the Fed’s balance sheet.
In the long period before the Fed started raising interest rates again, there was considerable divergence of opinion about the timing, with hawks pushing for hikes sooner and doves wanting to wait.
It resulted in a cacophony of voices that often left investors confused and uncertain about what the Fed was trying to say. That is over now, as policymakers seem to be on the same page, with a coherent message.
Mary Daly, head of the San Francisco Fed, says quantitative easing should now remain in the Fed’s toolkit. Not necessarily for the ordinary conduct of monetary policy, but, along with forward guidance, in a toolkit “when economic conditions warrant it,” she said in an interview with The Wall Street Journal.
Daly noted that interest rates remain the Fed’s primary monetary policy tool and the one in which she has the most confidence. There is still a debate about the effects of QE, so she has somewhat less confidence in that. Nonetheless, “I don’t have any experience so far that would suggest, from looking at the research on this, that we should throw any of those tools out.”