Minutes Set the Stage for Half-Point Hikes and Commencement of a More Rapid Drawdown of the Balance Sheet
by Craig Dismuke, Dudley Carter
The Minutes from the FOMC Meeting held on March 15 and 16 reflected the Fed’s increasingly hawkish posture towards defending its credibility, clearly laying out aggressive plans to tighten monetary policy at a rapid pace to try and rein in the fastest inflation since the 1980s.
50bp Hikes Clearly in the Cards: Consistent with current market pricing and the more aggressive tone from Fed officials, both hawks and doves alike, a 50-bp rate increase at a coming meeting is increasingly gaining traction as the crowd favorite. The Minutes noted that “one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified” and indicated that “many” would have preferred a 50-bp hike in March, absent the uncertainty created by Russia’s invasion of Ukraine.
Balance Sheet Normalization Details Take Shape – Faster and Larger: The more novel news, however, related to the proposed details around the Fed’s plans to begin shrinking the size of its balance sheet. Participants supported a plan to draw down the securities portfolio “in a predictable manner primarily by adjusting the amounts reinvested of principal payments received.” However, “all participants agreed that elevated inflation and tight labor market conditions warranted a faster pace of decline in securities holdings than over the 2017–19 period” and that the process could get underway as soon as the May meeting. In that regard, “Participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate. Participants also generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warrant.” The size of the caps and the phase-in period are notably more aggressive than the normalization process that was announced in June 2017. In that episode, monthly caps of $10 billion ($6 billion Treasury securities, $4 billion MBS) were “gradually” stepped up “at three-month intervals over 12 months” to a final cap of $50 billion ($30 billion, $20 billion).
In the finer details of the plans discussed, redemption of Treasury coupon payments would be prioritized with Treasury bill holdings used to take monthly roll-off up to the cap. As it relates to the Fed’s holding of agency MBS securities, officials foresaw scenarios in which paydowns will not reach the monthly cap, implying the caps are a backstop to prevent “outsized reductions” that could disrupt markets. The reinvestment method means that “agency MBS holdings would still make up a sizable share of the Federal Reserve’s asset holdings for many years.” Therefore, “Participants generally agreed that after balance sheet runoff was well under way, it will be appropriate to consider sales of agency MBS to enable suitable progress toward a longer-run SOMA portfolio composed primarily of Treasury securities. A Committee decision to implement a program of agency MBS sales would be announced well in advance.”