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Powell sees early on the $ 4 trillion Fed question

NEW YORK / SAN FRANCISCO (Reuters) – Federal Reserve Chairman Jerome Powell has one problem: how to explain that the Fed could soon start reducing the ongoing asset-shedding process without expect him to fight for an upcoming recession cave visit to US President Donald Trump.

FILE PHOTO: Chairman of the US Federal Reserve, Jerome Powell, attends a no-noon discussion on January 10, 2019 in Washington, USA. REUTERS / Jim Young / File Photo

Expected by Powell not long ago, this delicate communication test will be forthcoming some time later in 2019 and not at its press conference on Wednesday after the end of the Fed's first political meeting of the year.

But three things – an unexpected shortage of Wall Street reserves, public pressure from investors and the White House and the Fed's own decision to rethink their interest rate hikes – are forcing the US Federal Reserve to recognize the real possibility to keep more bonds than originally planned.

"They can not stop the rate hike cycle without also communicating on the balance sheet," said Thomas Costerg, US economist at Pictet Wealth Management in Geneva, Switzerland.

A larger balance sheet could lead to a general easing of the borrowing costs of the market and the foreign exchange value of the dollar, thereby burdening the emerging markets. This could also affect the Fed's appetite for bond purchases in the face of a future US downturn.

For more than a year, the Fed has cut its multi-trillion dollar balance sheet – from nearly $ 4.5 trillion – to around $ 4.1 trillion – without much ado.

Instead, the eyes of the world have been directed at a series of rate hikes that may have come to an end after careful communication from policymakers in recent weeks.

At the end of last year, however, prominent investors blamed the Fed's balance sheet outflow for market volatility. To underscore the adverse effects of the reversal of bond purchases by the Fed, the Quantitative Easing program, which had been used to stimulate the economy during the financial crisis, described it as a "quantitative tightening" (19659004) In December, Trump deepened the topic and tweeted it that the central bank should not make another mistake and stop at the 50-B levels – an indication of the $ 50 billion maximum in bonds that caused the Fed to shrink its portfolio every month, according to a plan he made 2017 sketched and started.

A day after the tweet, when Powell said the runoff had remained on "autopilot", the Standard & Poor's 500-stock index delivered the worst 60-minute minute sell-off in at least a year.

Two weeks later, when Powell emphasized that the plan was indeed flexible, the index provided the best 60 minutes in at least a year.

Trump's Tweet revealed a dilemma for the Fed: although the 2017 plan separated monetary policy from balance sheet accounting, markets are seeing a stronger connection. If the Fed wants to hold that the balance sheet does not become a first responder tool against economic ups and downs, Powell must keep this divorce in the books.

"I do not think they'll stop," said Chuck Self, chief investment officer at iSectors LLC of Appleton, Wisconsin. "They want to keep it as low as possible without disturbing the economy."


The central bank is actually approaching the point where it needs to adjust its balance sheet plan, not because of the state of the domestic economy, which appears strong but due to the outflow of short-term markets.

With the decline in the portfolio, banks have reduced the reserves they hold with the Fed by even higher amounts, weighing on the Fed's ability to control the short-term key interest rates it controls with monetary policy.

Economists had speculated last summer that the shortage of reserves and the resulting rise in interest rates would have to go beyond a target range. The sting would end two years earlier and cost the Fed $ 1 trillion than it had imagined.

For its part, the Fed intends to cut its portfolio to undisclosed levels, with demand for reserves in line with supply, but not as low as the $ 900 billion that existed before the 2007-2009 recession Purchase prompted.

"It will be much smaller than it is now … but it's not nearly as it was before," Powell said on January 10, calling each decision a technical decision rather than a referendum over the entire political point of view.

Growing balance-sheet issues could lead Powell to devise a clearer asset roadmap at 2:30 pm. (19:30 GMT) Wednesday conference.

"You must start with it," said Darrell Duffie, a professor at the Stanford University Business School, about the policy change. "They are not lashed now, but the longer they wait, the more they get locked up."

After gradually raising key rates last year, the US Federal Reserve is trying to further tighten monetary policy in the face of an overseas slowdown and market volatility.

Long hibernation? Global Weakening Market Fears May Extend Fed Break A series of domestic and global factors put the Fed's interest rate hikes down until 2016, and futures markets responded by reducing the gap or spread between forward-looking contracts , The Fed did not move until the spread recovered. A similar dynamic is developing today.

But even if interest rates remain stable this year, the ongoing liquidation of assets, which has totaled around $ 380 billion since October 2017, will continue to worsen financial conditions by increasing funding for banks.

In 2017, the Fed expected a cut in the portfolio until about 2022, when it would hold $ 2.3 trillion at $ 2.9 trillion.

However, Fed minutes in December showed a growing internal debate in which policymakers vigorously considered holding a larger "buffer" of securities than planned or slowing down the pace of the run as the finish line approaches ,

In mid-2018, economists at Deutscher Bank Securities were under the forecast that the Fed would have to stop the process by early 2020 with assets of around $ 3.7 trillion.

The memorandum, she wrote in a note, has further offset the risk-offsetting and convinced them that Powell will discontinue its portfolios in the third quarter of 2019.

In a possible preview of Powell's message, New York Fed President John Williams, a permanent voter in the Fed's policy-making body, said on January 18, "If circumstances change, I'll make our decisions regarding Monetary policy, including the balance sheet, re-evaluate normalization. Data dependency applies to everything we do.

Reporting by Jonathan Spicer and Ann Saphir; Additional coverage by Trevor Hunnicutt; Editing by Leslie Adler

Our Standards: The Thomson Reuters Trust Principles.

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