The Fed’s Policy and Its Balance Sheet

At its June meeting, the FOMC again raised the target range for the federal funds rate by 25 basis points, to 1 – 1 percent. They did so despite evidence that inflation had moderated and that the second estimate of first quarter GDP growth was clearly subpar at 1.2%. Furthermore, despite the fact that 7 of the 12 Federal Reserve district banks had characterized growth in the 2nd quarter as ‘modest,’ as compared with only 4 banks that described it at ‘moderate’ (the NY bank simply said that growth had flattened), the FOMC in its statement described growth as ‘moderate’ (here one needs to know that in Fed-speak ‘modest’ is less than ‘moderate’). The overall discussion evidenced in the statement and subsequent explanations by Chair Yellen in her post-meeting press conference, together with the fact that the only significant change in June’s Summary of Economic Projections was a slight downward revision in the unemployment rate for 2017, failed to make a convincing argument to this writer that there was a compelling case for a rate move at this time. The principal conclusion we can draw is that the FOMC had already conditioned markets to expect an increase in June and that the FOMC’s main rationale was its desire to create more room for policy stimulus should the economy take a sudden turn to the downside.
More significant than the rate move, however, was the detail the FOMC provided on its plan to normalize its balance sheet, which elaborated on the preliminary plan it put forward in March. Once the Committee decides to begin that process, it will employ a set of sequentially declining caps, or upper limits, on the amount of maturing assets that will be permitted to run off each month. The cap for Treasury securities will initially be $6 billion per month, and it would be raised in increments of $6 billion every three months until $30 billion is reached. Similarly, the cap for MBS will be $4 billion per month, which would also be raised by that amount every three months until $20 billion is reached. These terminal values would be maintained until the balance sheet size is normalized. Left unsaid was what the size of the normalized balance sheet would be.

This post was published at FinancialSense on 06/19/2017.