The flow of the Fed’s balance sheet will be rapid, Brainard says

April 5 (Reuters) – Federal Reserve Governor Lael Brainard said on Tuesday that she expects a combination of rising interest rates and a quick balance sheet to bring US monetary policy to a “more neutral position” later this year, with further tightening next year. needed.

On Wednesday, the Fed will release the minutes of its March meeting, which is expected to provide fresh details of its plans to cut bonds, and Brainard’s remarks gave a slight preview.

“I think we can all agree that inflation is too high, and lowering inflation is paramount,” Brainard told a Minneapolis conference.

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To do this, she said, the Fed will raise rates “methodically” and next month will begin to reduce its balance by almost $ 9 trillion, quickly reaching “significantly” faster runoff than last time. The Fed has cut its reserves.

The rapid reduction in the portfolio “will contribute to tightening monetary policy compared to the expected rate increase, which is reflected in market prices and a summary of the Committee’s economic forecasts,” she said.

The hawkish tone of one of the Fed’s usually more pigeon-like politicians led down stocks, and Treasury yields rose to multi-year highs as investors digested the effects of more aggressive policies.

Investors are concerned about “the speed and aggressiveness of the Fed with its balance sheet cuts,” said Sam Stoval of CFRA Research.

The Fed raised rates last month for the first time in three years and published forecasts showing that most politicians believed the political rate would end the year at least in the range of 1.75% -2%, if not higher. This will require an increase in the rate by a quarter of an item at all six other Fed meetings this year.

Markets are seeing the Fed move faster, providing a rate increase of half a point in May, June and July to bring the rate to 2.5% -2.75% by the end of this year. Most politicians view 2.4% as a “neutral” level, above which the cost of borrowed funds begins to slow growth.

“Given that the recovery was much stronger and faster than in the previous cycle, I expect the balance to shrink much faster than in the previous recovery, with much higher limits and a much shorter period before the maximum restraint phase compared to 2017– 19, ”Brainard said.

Then the Fed began by limiting the outflow from its balance sheet of $ 4.5 trillion to $ 10 billion a month, and it took a year to increase that figure to a maximum of $ 50 billion a month. Analysts expect that this time the pace will be twice as high.

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The Fed focuses on inflation at 2%, as measured by the price index for personal expenses. In February, the PCE price index rose 6.4% from a year earlier, and Brainard said she sees risks of further growth as Russia’s invasion of Ukraine pushes gas and food prices and China’s COVID blockades exacerbate bottlenecks. supply chains.

And while geopolitical developments could pose risks to growth, she noted, the U.S. economy has a significant boost and the labor market is strong, unemployment is now 3.6%, which is a hair above the pre-pandemic level.

According to Brainard, the Fed’s policy signals have already tightened financial conditions, and mortgage rates have risen by a percentage point over the past few months.

“We are ready to take more decisive action if justified by inflation readings or inflation expectations,” Brainard said, adding that she would also monitor the yield curve for any signs of lowering risk to the economy.

From Brainard’s remarks, it was unclear whether she believed a rapid portfolio drain would make it unnecessary to raise rates more than usual.

Fed Kansas City President Esther George, who also advocates a faster balance sheet, has left the door open.

“I think 50 basis points would be an option we should consider along with other things,” George told Bloomberg TV on Tuesday.

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If the Fed does raise rates as fast as markets now predict, it will be the fastest rate of policy tightening in decades in at least a few months.

Fed Chairman Jerome Powell says he believes the Fed can manage a “soft landing” if the central bank raises borrowing costs enough to slow the economy and lower inflation, but not enough to cause unemployment to rise or push the economy into recession.

Economists say it will be difficult or even impossible: in a recent paper by Harvard University’s Larry Summers noted that since 1955 there has never been time for wage growth to exceed 5% and unemployment to be below 5%, which was not observed for two years. by recession.

Hourly wages of non-managerial workers in January, February and March increased by 6.7% compared to the same period last year, according to the Ministry of Labor.

However, Fed officials say the past is not necessarily a prelude. On the one hand, workers are already leaving the sidelines of the job market when the pandemic weakens, and much of this trend could ease wage pressures.

On the other hand, the United States is a net exporter of oil, so rising energy prices will not slow the economy as much as it did in the 1970s, making stagflation less likely.

“I don’t expect us to fall into recession,” San Francisco Fed President Mary Daly said at a meeting of the Association of Indian Financial Officers in Seattle.

When the Fed tightens its anti-inflation policy, it said: “We could slow down, so it looks like we’re running close to it, it’s possible, but I expect it to be a short-term event, and then we’ll be back.”

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Report by Anne Sapphire and Lindsay Dunsmoor; Additional reports by Bansari Mayur Kamdar, The Wrong of Paramasivo and Rodrigo Compass; Edited by Andrea Ritchie

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