Last week the US Federal Reserve lifted short term rates by another quarter point, meeting analysts’ expectations. However, the Fed also surprised by announcing its plans for paring back the size of its balance sheet during the second half of this year; something analysts had not been expected for some time.
Despite weak inflation figures, the Fed pressed ahead with its decision to increase rates, and policymakers remain set on plans to increase rates further in the coming years, including another quarter-point increase by the end of 2017.
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Along with this bullish rate forecast, Fed policymakers updated a previous document setting out their principles and plans for normalizing the balance sheet last week. While Janet Yellen declined to say when the central bank would begin to action this plan, the extra color offered within the Fed’s update will allay some concerns analysts have expressed about the Fed’s lack of planning when it comes to balance sheet normalization.
According to the plans, the Federal Open Market Committee will reduce reinvestment of principal payments received on maturing securities in its portfolio. Payments will only be reinvested to the extent they exceed a set of gradually rising caps. The FOMC anticipates that the first cap will start at $6 billion per month and increase at a rate of $6 billion on three-month intervals over 12 months until it reaches $30 billion a month. For mortgage-backed securities, caps will start at $4 billion per month and increase in steps of $4 billion at three-month intervals for 12 months until they reach $20 billion per month.
The fact that the Fed is planning to initiate this balance sheet normalization in the near future surprised some analysts because the more bearish economists still believe that the global economy cannot yet stand on its own two feet without central bank support.
Economists at investment bank Morgan Stanley ponder this topic in a research note sent to clients last week. The bank’s analysts draw the conclusion that while some economists believe the global economy cannot withstand monetary policy normalization, the impact on growth will be entirely dependent on private sector demand and fiscal support.
