As a benchmark, my own expectation has been for (1) additional 25 basis point policy rate increases in both June and September, (2) a decision to begin shrinking the balance sheet at the December meeting, and (3) balance sheet run-off to subsequently begin in January 2018. In slight contrast, the March minutes state that “most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the Committee’s reinvestment policy would likely be appropriate later this year.” There are different ways to interpret this but I now expect run-off to begin in Q4, based on a decision taken at either the November 1 or mid-December meeting.
Specific plans for the balance sheet are still to be finalized, but the minutes provide a clear sense of how most Committee participants are leaning:
- Reductions in the balance sheet should be “gradual and predictable, and accomplished primarily by phasing out reinvestments”;
- The policy rate will remain the primary tool for adjusting policy, whereas balance sheet reduction will be “passive”, essentially running on auto-pilot in the background so long as the outlook does not change drastically;
- When run-off begins, it will occur for both the Treasury and agency MBS portfolios.
There are still a number of details that need to be filled in. Most importantly, there is an ongoing debate about whether run-off should begin when a specific level of the target range for the federal funds rate is reached, or whether the decision should be based on a more qualitative assessment of conditions. Here is the relevant passage:
“Several participants indicated that the timing should be based on a quantitative threshold or trigger tied to the target range for the federal funds rate. Some other participants expressed the view that the timing should depend on a qualitative judgment about economic and financial conditions. Such a judgment would importantly encompass an assessment by the Committee of the risks to the outlook, including the degree of confidence that evolving circumstances would not soon require a reversal in the direction of policy.”
The weight of participants (not voters) seems to be in the camp of a quantitative threshold. Still, I am skeptical that the Committee would announce a specific threshold for RIOER, as I think core Committee members would prefer the flexibility to respond to financial conditions and the evolving outlook as rate increases continue, and decide on the timing of balance sheet run-off accordingly. But perhaps this is a moot point – even if they do not announce a specific level of RIOER for commencing run-off, their communications will make the timing perfectly clear. For example, reading through the minutes and keeping the SEP dot plot in mind, it seems fairly obvious that the Committee views a 1.50 percent RIOER as the threshold for beginning balance sheet runoff.
Other topics on run-off that still need to be addressed include the following:
- The phasing-out of reinvestments will occur in both Treasury securities and agency MBS, but will the Committee target roughly equal amounts of run-off across the two portfolios?
- Will the Committee seek to smooth through the variability in monthly Treasury maturities, either during the “tapering” of the reinvestment policy or when the portfolio is in full run-off mode?
Finally on the balance sheet, “several participants indicated that…it would be desirable to also provide more information to the public about the Committee’s expectations for the size and composition of the Federal Reserve’s assets and liabilities in the longer run.” This gets to the question of whether the Committee will ultimately target a higher level of reserves in the system compared to the pre-crisis approach, or operate with a somewhat larger balance sheet in a longer run “steady state”. This would certainly be useful information, but I suspect that there is not yet sufficient consensus on this issue for the Committee to provide clarity.
Elsewhere in the minutes, I was struck by the fact that a number of participants judged that the inflation goal had largely been met:
“However, several other participants judged that–with the headline PCE price index rising nearly 2 percent and the core PCE index increasing close to 1-3/4 percent over the 12-month period ending in January–the Committee essentially had met its inflation goal or was poised to meet it later this year. In the view of these participants, such circumstances could warrant a faster pace of scaling back accommodation than implied by the medians of participants’ assessments in the SEP.
This view is not altogether surprising given the diversity of views on the Committee, but the language still represents a shift from the prior meeting, when more hawkish members were still speaking in terms of inflation approaching the Committee’s objective. The view that inflation is basically at a mandate-consistent level has not yet spread to voting members, but even here there is a subtle shift: “nearly all” members believe that the Committee “had not yet achieved its objective for headline inflation on a sustained basis”, implying that one or two believe the objective has largely been met.