Weekly Update: Busy Week for Fed Balance Sheet and New Framework

The FOMC minutes that were released on Wednesday confirmed that the Fed will end balance sheet runoff during the second half of this year, with an announcement likely to come sooner than that. The discussion of the macro and policy outlook suggested that the FOMC’s patient stance is likely to prevail through June, if not longer. This is consistent with our rate path call that there will be no more rate hikes. (For our full  commentary, click here.) Last week provided further disappointing incoming economic data, with core capital goods orders declining in December from a November level that was marked down. But markets have been focused on U.S.-China trade negotiations, and on this front recent developments have been heartening. Citing the progress made in recent talks, President Trump said he would delay an increase in tariffs that had been set to take effect if there was no deal by the March 1 deadline and referenced the prospect of a “signing summit” for a deal. 

The other major monetary policy event last week was the Monetary Policy Forum, an event at which several key policymakers spoke. Clarida provided the most comprehensive outline to date of what the monetary policy review that the Fed will undertake this year will entail. His discussion of the issues motivating this review suggested that there is concern about the existing framework, particularly concerning low inflation and inflation expectations. (For our full commentary, click here.

The balance sheet normalization plans continued to be at the forefront of the policy discussion. Quarles  delivered a speech in which he reiterated that it might be appropriate for the Fed to conduct policy using “a  sizable quantity of reserves large enough to buffer against most shocks to reserve supply.” To him, the  September survey of banks implied an efficient level of $800 billion. However, a “degree of caution,” which likely means a buffer on top of that, is necessary. Nevertheless, he noted that “The existing level of reserves  is quite a bit higher than what the banks are telling us is their demand for reserves.” He also said that “All  things considered we should go back to a shorter duration.” He implied that shortening duration now would create space for lengthening the duration during the next downturn. He deemed aligning the portfolio’s profile with that of outstanding Treasuries a good practice, generally speaking. Given the Fed’s current portfolio, this would entail shortening the duration of its holdings. Mester (Feb. 19) agreed with ending runoff in 2019 and  preferred not to taper the runoff caps: “if you can announce sooner what you’re doing in the future, then  there’s less need to taper.” She, too, wanted to “skew [the portfolio] towards short-term Treasuries,” so it is  “shorter duration than this current balance sheet.” Williams’ figure for reserves was “maybe $1 trillion of  reserves or somewhat more than that.” Harker (Feb. 22) thought that ending runoff this year would be preferable. Bullard (Feb. 22) argued that the principal effect of QE came via the signal it provided about the rate path. He saw the macro effects of runoff as being minor. 

Additionally, several other policymakers continued to reiterate the “patience” message. Bostic (Feb. 22)  still saw a very slow pace of rate hikes—one in 2019 and one in 2020. He saw the current target range as  “close to neutral.” Likewise, Daly thought it was within “a hair’s breadth of neutral.” Williams (Feb. 22)  warned that the Phillips curve is “alive and well,” although he also cautioned that the “persistent undershoot  of the Fed’s target risks undermining the 2 percent inflation anchor.” He (Feb. 19) thought there was no need for further rate hikes unless the outlook for growth or inflation surprised to the upside. He urged continued vigilance about the possibility of deteriorating longer-run inflation expectations. Kaplan (Feb. 20) thought the  

the yield curve was “a bit of a warning signal.” Daly (Feb. 22) argued that the Phillips curve is still operative, but wage growth is increasing only slowly and not in an alarming manner. She saw little cyclical inflation pressure and singled out health care costs as no longer boosting inflation. Bullard’s baseline case (Feb. 21) was also for no rate moves this year. 

Nowcasts (2018:Q4) 

Source Current One Week Ago Two Weeks Ago
Atlanta Fed GDPNow 1.4% 1.5% 2.7%
New York Fed Staff Nowcast 2.3% 2.2% 2.4%
CNBC/Moody’s Survey 2.0% 2.4% 2.7%

Recent Data

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
Core Capital Goods Orders MoM Dec P -0.7% 0.2% -1.0% -0.6%
Core Capital Goods Shipments MoM Dec P 0.5% 0.0% — -0.2%
Existing Home Sales MoM Jan -1.2% 0.2% -4.0% -6.4%

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