– Outlines Fed’s Balance Sheet Reduction Strategy
By Steven K. Beckner
(MaceNews) – Federal Reserve Chair Jerome Powell reaffirmed Wednesday his strong message that the Fed will be raising short-term interest rates again in all probability.
Testifying on the Fed’s semi-annual Monetary Policy Report to Congress, Powell largely reiterated what he said last Wednesday after the Fed’s rate-setting Federal Open Market Committee left the federal funds rate unchanged in a 5.0% to 5.25% target range after 10 straight rate hikes totaling 500 basis points.
He went out of his way to tell the House Financial Services Committee that the FOMC decision to stand pat on June 14 was not a “pause,” although he also avoided saying that the Committee had “skipped” a meeting, as many of his colleagues had been saying.
Rather, Powell said the FOMC had merely decided to keep the funds rate steady “at that meeting” and that most of its participants expect to raise rates further. He was obviously referring to the FOMC’s revised quarterly Summary of Economic Projections and accompanying “dot plot,” which showed Fed officials projecting that the funds rate will climb to a median 5.6% (5.5 to 5.75%) by the end of this year – 50 basis points higher than in the March SEP. Projections ranged from 5.1% to 6.1%. Both numbers are up from March.
Powell portrayed last Wednesday’s decision to leave rates unchanged as a chance for the FOMC to take its time to sort out economic and financial uncertainties and to give past rate hikes, plus actual and anticipated bank credit tightening a chance to work. If inflation fails to moderate further as hoped, the FOMC will stand ready to raise rates further, he made clear.
“In light of how far we have come in tightening policy, the uncertain lags with which monetary policy affects the economy, and potential headwinds from credit tightening, the FOMC decided last week to maintain the target range for the federal funds rate at 5 to 5-1/4 percent and to continue the process of significantly reducing our securities holdings,” Powell said in prepared testimony, which will be re submitted tomorrow to the Senate Banking Committee.
Powell added, “Nearly all FOMC participants expect that it will be appropriate to raise interest rates somewhat further by the end of the year. But at last week’s meeting, considering how far and how fast we have moved, we judged it prudent to hold the target range steady to allow the Committee to assess additional information and its implications for monetary policy.”
Elaborating in response to questions from congressmen, Powell took exception to one legislator’s use of the word “pause” to describe the FOMC’s decision not to raise the funds rate. What’s more, although he had previously said the funds rate “dots” are “not a plan,” Powell virtually endorsed participants’ projections of two more rate hikes.
“We never used the word ‘pause,’ and I wouldn’t use it here today,” he said. “What we did was we agreed to maintain the rate at that meeting.”
“Almost every single – 16 of the 18 participants on the FOMC — wrote down that they do believe it will be appropriate to raise rates, and a big majority believes … raise rates twice this year,” Powell continued.
“And I think that’s a pretty good guess of what will happen if the economy performs about as expected.” he added.
Powell continually talked about how “very tight” the labor market is and how that is keeping upward pressure on inflation through core services ex-housing. He said “the process of getting inflation down will take a significant amount of time” that will require both slower growth and “softening” labor markets to “realign” supply and demand.
“We do believe the process of bringing inflation down is going to be a relatively lengthy one – longer than we would have expected,” he went on.
Powell repeatedly asserted the Fed’s commitment to reducing inflation to 2% and denied that it would modify that target.
He reiterated that “inflation remains well above our longer-run goal of 2 percent” and that although it “has moderated somewhat since the middle of last year,” “inflation pressures continue to run high, and the process of getting inflation back down to 2 percent has a long way to go.”
At last week’s meeting, the FOMC also authorized continued balance sheet reduction at a pace of $95 billion per month by allowing maturing Treasury and agency mortgage-backed securities to “roll off.”
But one congressman expressed concern that the Fed’s “quantitative easing” of the past is outpacing current balance sheet reductions. Powell sought to reassure him.
“It is a concern, and … that’s why this time balance sheet roll-off is much faster than in the first episode…,” he said. “We are moving back down to a level that would be appropriate for our new framework (excess reserves).”
“By the way, we won’t be going back to a framework where we were dealing with scarce reserves,” Powell continued. “We like the administrative rate framework we’re in right now. But it is important to have the balance sheet not just grow with every cycle, and I’m very conscious of that.”
Asked about the “optimal target” for the size of the balance sheet, Powell responded:
“You find the number. The idea is that it’s smaller than now. It’s a place where reserves are abundant and also have a little buffer on top of that, so we don’t accidentally run into reserve scarcity. Demand for reserves can be volatile, and you don’t want to find yourself as we did a few years back suddenly finding that reserves were scarce, even though we didn’t see it coming and we suddenly had to put more reserves into the system at a time when we didn’t want to have to deal with that.”
“So I think you want to have a level of ample reserves plus a buffer, and that will be a percent of GDP that we get down to. And we’re moving in that direction pretty smartly,” he added.
Asked how fast the Fed can shrink the balance sheet without disrupting markets, he replied: “We don’t sell assets; we allow them to mature and passively run off…that’s what we’re doing to a tune of about $1 trillion per year. We’re in the middle of that process now….”
“It’s an empirical question, Powell continued. “You’re going to find a level that’s still ample plus a bit of a buffer, and that’s how we’re thinking about it.”
Meanwhile, the Atlanta Federal Reserve Bank released an essay by its president Raphael Bostic, in which he argues that past fed funds rate hikes need to be given more time to work before raising it further.
Bostic, who is not a voting member of the FOMC this year, contended that “policy has been restrictive for only eight to nine months. Therefore, the real economic effects of tighter monetary policy are only just beginning to take hold. “
“We know that with a fair degree of certainty. What we don’t know is exactly how responsive our brakes are, how quickly policy will bite more deeply and in turn how quickly inflation will fall. I expect it will continue to come down gradually, with bumps along the way,” he said.
Bostic said he is the “camp” of those who argue that “policy may now be sufficiently restrictive, but we have not yet seen its full effects on the macroeconomy. So, let’s pause and give policy time to work and assess how rapidly it is gripping the real economy. Under this view, the bar to justify further rate hikes is higher than it was a few months ago.”
‘I think we are in a place where we should let the hard work the Committee has already done work its way through the economy and see if it continues to bring inflation closer to our goal,” he elaborated. “Letting restrictive policy work for a while is prudent because the policy has been truly restrictive for less than a year, and it takes time for monetary policy changes to meaningfully influence economic activity.”
Bostic also contended that “waiting is not the same thing as inaction. If inflation continues to fall in coming months, our current policy stance effectively becomes tighter, as the real interest rate—which is the difference between our rate and the rate of inflation—will increase.”