Fed's Brainard Backs Balance-Sheet Runoff ‘Soon,’ Wary on Rates

Federal Reserve Governor Lael Brainard sounded a note of caution over further interest-rate increases while signaling she’s comfortable with pressing ahead “soon” with plans to start shrinking the central bank’s $4.5 trillion balance sheet.

“I will want to monitor inflation developments carefully, and to move cautiously on further increases in the federal funds rate, so as to help guide inflation back up around our symmetric target,” Brainard said in the text of a speech she’ll deliver Tuesday in New York.

Brainard said the Fed’s policy rate -- currently in a target range of 1 percent to 1.25 percent -- was not far from its neutral level that would neither stimulate nor hold back economic growth.

“The neutral level of the federal funds rate is likely to remain close to zero in real terms over the medium term,” she said. “If that is the case, we would not have much more additional work to do on moving to a neutral stance.”

Brainard led the dovish side of the Fed’s rate debate through much of 2016, arguing that global economic conditions made tighter monetary policy risky. She backed increases in December and twice this year amid a rosier international picture and signs of gathering inflation in the U.S.

That momentum in inflation has disappeared in recent months, however, with the core measure of the Fed’s preferred gauge slowing to 1.4 percent in the 12 months through May, well below the central bank’s 2 percent target.

On the balance sheet, Brainard indicated a willingness to get its roll-off underway.

“If the data continue to confirm a strong labor market and firming economic activity, I believe it would be appropriate soon to commence the gradual and predictable process of allowing the balance sheet to run off,” she said.

Overall, her comments suggest she’d back the start of balance sheet reduction as early as September, but she might resist a rate hike before the end of the year. Investors expect the Fed to hike once more in 2017, most likely in December, according to pricing in federal funds futures contracts.

She used much of her speech to examine the options facing central bankers in major economies around the globe as they remove or consider removing record levels of policy accommodation.

“With synchronous expansions now underway, we may be approaching a turning point before too long,” she said.

She warned that raising interest rates and trimming bloated balance sheets, while having similar effects on domestic economic conditions, could carry very different cross-border implications. Specifically, she posited that interest-rate hikes may have a greater impact on currency values, and thus on other countries, than balance-sheet reductions.

“If the cross-border spillovers of reductions in the balance sheet and increases in the policy rate are not equivalent, the sequencing of policy rate and balance sheet normalization could have important implications for the exchange rate and external balance,” she said.