By Steven K. Beckner
(MaceNews) – Federal Reserve Governor Christopher Waller Friday said the Fed should start raising short-term interest rates “shortly” after it finishes buying bonds in March – perhaps immediately thereafter.
What’s more, Waller advocated starting to shrink the Fed’s bloated balance sheet soon after it starts raising the federal funds rate, which would augment monetary tightening.
However, he suggested the Fed’s policy making Federal Open Market Committee may want to “pause” after two or three rate hikes to see how the economy is responding not just to rate hikes but also to virus developments.
Waller told the Forecasters Club of New York he expects inflation to moderate, but said there are “upside risks,” to which the FOMC must be prepared to respond if it is to avoid damage to the economy.
Waller’s comments came two days after he joined a unanimous FOMC in voting to double the pace at which it is phasing out asset purchases. By tapering bond buying by $30 billion per month, the Fed’s policy making body put bond buying on track to end by mid-March.
The FOMC left the federal funds rate unchanged in a zero to 25 basis point target range, but all 18 participants projected multiple rate hikes next year, putting the median funds rate at 0.9% by the end of 2022.
Waller, who was one of the first policy makers to outspokenly advocate an early wind-down of the asset purchase program and an early liftoff, strongly suggested the FOMC should not long delay “liftoff” from the zero lower bound.
“The appropriate timing for the first increase in the policy rate, of course, will depend on the evolution of economic activity, something that I will be closely monitoring,” he said in prepared remarks. “But given my expectations for inflation and labor market conditions, I believe an increase in the target range for the federal funds rate will be warranted shortly after our asset purchases end.”
Waller was even more emphatic when responding to questions, declaring that the FOMC’s scheduled March 15-16, 2022 gathering should be a “live meeting” as far as active consideration of a first funds rate hike is concerned.
“The whole point of accelerating the taper was to end it much faster in March, so that March will be a live meeting,” he said, adding that an initial 25 basis point rate hike in March is “a very likely outcome.”
Waller said “liftoff” could be pushed to the May 3-4 meeting, but said “it would take something like a severe disruption of Omicron … to keep March from being key date for liftoff” in his mind.
“I would like to put March on table as the possible date for liftoff as necessary,” he added.
But Waller wasn’t finished with his hawkish monetary prognostications. Once the Fed stops expanding its balance sheet and rate hikes start, he said the FOMC should get on with actually shrinking the balance sheet, he maintained.
After the Fed ended its third round of quantitative easing in 2014, it waited more than a year to start tentatively raising the funds rate and waited even longer to start shrinking the balance sheet.
But “this time is very different from last time,” Waller said, noting that in 2014-15, “the economy was recovering slowly” from the financial crisis.
“The situation is very different now,” he continued. “The economy has recovered much faster. … We’re near full employment and inflation is well above target.”
Therefore, he said, “I see no reason to delay balance sheet adjustment.” He added that he doesn’t like the term balance sheet “normalization.” He said the FOMC has begun discussing that process and will be doing so further before eventually publishing guidance on how the Fed will proceed to shrink its enormous bond portfolio.
Noting that the Fed’s balance sheet has grown from 20% to 35% of GDP, Waller said, “We can’t wait to grow our way into the balance sheet; we have to take actions to shrink it.” He said 20% would be “a reasonable benchmark to get to.”
“We can go much sooner and faster than we did last time,” he reiterated. “We could start reducing the balance sheet not too long after liftoff – maybe not right after liftoff … but within few meetings.”
Waller suggested that initially maturing mortgage backed securities “could be reinvested back into short-term Treasuries,” which could then be “run off quickly.”
Waller also observed that the Fed has been absorbing vast amounts of the liquidity the Fed has created through its overnight reverse repurchase facility, where yield-seeking financial firms can park cash. This gives it greater leeway to shrink its balance sheet and in turn the reserves financial institutions are holding at the Fed.
“It’s pretty clear we can go faster on the balance sheet because I looked at the ON RRP facility, and there’s about $1 1/2 trillion of reserves that are being handed to us every day from the financial sector,” he said.
“This is $1 ½ trillion in reserves the market doesn’t want or need,” he continued. “They’d rather have securities than the reserves. So we could actually run that off very quickly — $1 1/2 off our balance sheet, and there should be no impact in terms of need for reserves in the financial system.”
So I think that’s one reason we can go much quicker,” went on. “So we can start sooner after liftoff – way sooner than before. I would say within a couple of meetings, and we can go much faster because we’ve put so much liquidity in the system that the market doesn’t really want it. So get it out of there.”
Waller pointed out that potential balance sheet shrinkage is not encompassed in the FOMC’s “dot plot” of projected rate hikes, but would work in the same direction.
While advocating a March liftoff, he said the FOMC can be flexible on the timing and pace of rate hikes as it takes a “risk management” approach. After raising rates “a couple of times” the FOMC could “pause” to “see what’s happening,” and if inflation cools that “would take a lot of pressure off of us” to keep raising rates.
On the other hand, if inflation does not moderate “we could bring more rate hikes into 2022,” he said.
FOMC participants projected that inflation will come down to 2.6% next year – half of the current rate. If that happens, Waller said that will tend to make monetary policy tighter because it will mean a higher real funds rate.
Contact this reporter: steve@macenews.com.
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