"Somebody had better give this all a lot more thought before starting to put potential time parameters on when we might be setting off on this treacherous trek."
The journey that Bloomberg's Richard Breslow is referring to is ending the reinvestment of maturing securities held on the Federal Reserve’s bloated balance sheet.
All of a sudden, we’re not hearing it's a noble goal, deserves study and should start after considerable progress has been made in raising the Fed Funds level toward the neutral rate -- the argument upon which the Fed’s dot plots are supposedly based.
We’ve just had three Fed speakers, including NY President Bill Dudley, mention the latter part of this year as potentially appropriate. This is a big change and a very big deal.
With all due respect to everyone with an opinion on this subject, no one knows how this is going to work in practice, let alone what it will do to markets.
If stability of financial conditions is the unofficial third mandate then buckle up. It could be like being the passenger in a car driven by someone struggling to work out getting from neutral into first gear on a steep hill.
Remember when we were assured that dealing with disinflation was the hard part, and there was a plan for how it would all get unwound? It sounded good at the time. Buying securities on a well advertised schedule was not the tour-de-force. Reducing holdings on a potentially start stop basis will take the real moxie.
In the last two weeks we’ve gone from risk-off to risk-on to, this morning, when the jury is out. Will the Fed be able to ignore these bouts of severe mood swings, especially if they’re longer lasting? They’d better. But as Dudley said, projections are forecasts, not commitments. Now multiply the complexity if we’re talking asset dispositions instead of 25 basis point hikes.
Just for a little context, Bloomberg’s Stephen Spratt calculates that the balance sheet’s Treasury holdings longer than 20-years maturity represents a full three years worth of long-bond supply. Not even mentioning all the MBS. How’s that for crowding out? And how many years is this going to take? Ever wonder why corporate America is stockpiling cash?
Getting the balance sheet down is an important long-term objective. Long-term thinking is not something we’re good at. But doing it without a lot of Fed Funds firepower to facilitate it is not going to be smooth. Embarking on this project merely to claim it as a milestone would be a policy mistake.
And as a strong reminder, it's not just The Fed balance sheet that we have to worry about...
