US Fed set to shrink balance sheet

The minutes showed that Fed officials mostly preferred to tie the change to the strength of the economy, and to gradually phase out reinvestments of the proceeds from the Treasury and mortgage-backed securities that mature, rather than suddenly ceasing reinvestments altogether.

When balance sheet reduction starts, it is likely to include shrinking both Treasury and mortgage-backed securities (CMBS) held in the portfolio, possibly by reducing the amount of coupon payments that are reinvested. "Most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the Committee's reinvestment policy would likely be appropriate later this year". If an economic disaster were to suddenly strike, however, and the interest rates were already at severely low levels, the central bank would be ill-equipped to respond. The Fed's assets leveled off at about $4.5 trillion around the end of 2014 and the total has lingered there since.

When analysts and observers of the USA economy discuss the Federal Reserve's policy moves, they often point to the federal funds rate-the bank-to-bank lending rate that's closely followed by interest rates on mortgages, credit card debt and other loans, which the Fed raises to rein the economy in during times of steady growth.

On inflation, the minutes showed that some Fed officials anxious that if unemployment, now at a low of 4.7 per cent, fell even further, it could pose a "significant upside risk" of higher inflation.

Regardless of what the minutes show, the message from Oxford Economics is that the central bank should tread cautiously given all the uncertainty.

But policymakers last month were divided as to how soon the world's largest economy is likely to hit two per cent "on a sustained basis", according to the minutes.

The minutes were released with the customary three week time delay after the March meeting.

Markets showed little reaction to the minutes. The Fed's two goals are to achieve maximum employment and moderate inflation.

What they all agreed on was that shrinking the balance sheet should be gradual and predictable and almost all said that any altering of the policy "should be communicated.well in advance of an actual change".

"The sudden shift in focus to the balance sheet" could, in part, reflect "possible concern about the rise (in) asset prices", wrote Jefferies economists Ward McCarthy and Thomas Simons.

France is due to stage the first round of its presidential elections later this month, with the far-right's Marine Le Pen, a critic of free trade and the European Union, poised to make a strong showing.

Wall Street finished lower following the minutes' release, with the major indices reversing gains made earlier in the day.

The S&P 500 was down 0.31%, the Dow Jones Industrial Average fell 0.20%, and the Nasdaq fell 0.58%.



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