By Jonathan Spicer and Ann Sapphir
NEW YORK / SAN FRANCISCO (Reuters) ̵
Not so long ago, Powell expected to launch this sensitive communication test sometime later in 2019, rather than at his press conference Wednesday after the end of The Fed's First Political Session 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 decision to rethink interest rate hikes – are forcing the US Federal Reserve to recognize the real possibility of more bonds to maintain as originally planned.
"They can not stop the rate hike cycle without communicating on the balance sheet," said Thomas Costerg, senior US economist at Pictet Wealth Management in Geneva, Switzerland.
A larger balance sheet could lead to a general easing of market borrowing costs and the foreign exchange value of the dollar. It 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 systematically cut its multi-trillion US dollar balance sheet from just under $ 4.5 trillion to around $ 4.1 trillion and falling – without much notice.
Instead, it has turned the eyes of the world on a series of rate hikes that may have come to an end after careful communication from policymakers in recent weeks.
But at the end of last year, prominent investors blamed the Fed's balance sheet for market volatility. To underscore the adverse effects of the reversal of bond purchases by the Fed, the Quantitative Easing program, undertaken during the financial crisis to boost the economy, described it as a "quantitative tightening" (19659010) 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. This is indicative of the $ 50 billion bond ceiling that caused the Fed to shrink its portfolio every month, according to a plan he outlined and started in 2017.
A day after the tweet, when Powell said the runoff had remained on "autopilot", the stock index of Standard & Poor's 500 delivered the worst 60-minute review 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: however, its 2017 divisive policies make markets look stronger. 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 go," 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."
A LARGER ROAD MAP
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 portfolio underperforming, banks have reduced even more the reserves they hold with the Fed, thereby straining the Fed's ability to control the short-term interest rates it controls monetary policy.
(GRAPHIC: Bank Reserve at the Fed – https://tmsnrt.rs/2BiDDzx) – 19659019] Economists had speculated recently To overcome the growing shortage of reserves and the resulting rise in interest rates beyond a target range, the spike would have to end two years earlier and burden the Fed with $ 1 trillion more than expected.
The Fed wants to bring its portfolio to an indeterminate level where supply demand is in line with supply – albeit not too low, like the $ 900 billion it held before the 2007-2009 recession, which led to purchases beginning ,
"It will be much smaller than it is now." But it's not nearly as far as before, "Powell said on January 10, formulating each decision as a technical rather than a referendum on the general political viewpoint.  Story Continues
Growing Issues on the Balance Sheet May Cause Powell Outlines a Clearer Inventory Schedule at 2:30 pm (7:30 GMT) Wednesday Press Conference.
"You Must Begin It," said Darrell Duffie, Professor Stanford University Business School, about changing politics. "They are not wrapped up now, but the longer they wait, the more they are imprisoned."
After the US Federal Reserve gradually raised key rates last year, it is doing so The US government has a wait-and-see attitude to further streamline its bonds Given the slowdown overseas and the volatility of the markets.
But even if the interest rate remain stable this year, the continued liquidation of assets, which has been around $ 380 billion since October 2017, will continue to worsen financial conditions by making banks more expensive to finance. 19659027] The Fed anticipated a portfolio reduction in 2017 until about 2022, when it would hold $ 2.3 trillion in assets worth $ 2.9 trillion.
However, Fed minutes in December showed a growing internal debate in which policymakers hold a larger "buffer" of securities than planned or slowed the pace of flattening as the finish line approaches.
Middle In 2018, German Bank Securities economists were among those who predicted that the Fed would have to stop the process by early 2020. Estimates of around $ 3.7 trillion.
The minutes, she wrote in a note, are at risk Balance even further postponed and convinced that Powell will stop the liquidation of the portfolio in the third quarter of 2019
In a possible preview of Powell's message, New York Fed President John Williams, a permanent voter on the committee, said on Fed policy decisions on 18 January: "If circumstances change, I will redo our monetary policy decisions rate. including the normalization of the balance sheet. Data dependency applies to everything we do.
(Reporting by Jonathan Spicer and Ann Saphir, additional coverage by Trevor Hunnicutt, Edited by Leslie Adler)