The Fed May Not Be the Master of Its Balance-Sheet Fate

  • FOMC may delay drawdown’s start if debt ceiling upsets markets
  • September still seen as most likely date for launch of program

OppenheimerFunds' Memani Says Fed Is 'Sitting Pretty'

The Federal Reserve signaled on Wednesday that it intends to kick off the long-awaited reduction in its $4.5 trillion balance sheet in September, although a final decision to go ahead may not be entirely its to make.

A looming deadline for raising the government’s debt ceiling could end up complicating the Fed’s plans if it significantly disrupts financial markets, particularly for U.S. Treasury securities.

“September is the most likely outcome” for the launch of the balance-sheet drawdown, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “But I can’t rule out the idea that they would wait until November if the debt ceiling really looks messy.”

The Trump administration has said it has the leeway to keep financing the government through September, but after that it will need lawmakers to raise the debt limit in order to avoid a default. That’s a point that U.S. Treasury Secretary Steven Mnuchin hammered at in an appearance before the Senate Appropriations Committee earlier on Wednesday.

Saying the threat of default is already creating uncertainty among investors, Mnuchin urged lawmakers to raise the ceiling before they leave for their summer recess.

He spoke just hours before Fed Chair Janet Yellen and her colleagues affirmed their intention to proceed with the balance-sheet rundown “relatively soon, provided that the economy evolves broadly as anticipated.”

That was viewed as signaling an announcement of the process at their meeting on Sept. 19-20 that would probably begin in October.

Also hanging over Wednesday’s meeting of the Federal Open Market Committee were remarks by President Donald Trump about whom he intends to nominate to be central bank chair when Yellen’s term expires in February.

He told the Wall Street Journal on Tuesday that Yellen “is in the running, absolutely” for the job, adding that he respected and liked her personally. “I’d like to see rates stay low. She’s historically been a low-interest-rate person,” he said, according to the newspaper. White House senior economic adviser Gary Cohn is also a leading candidate for the post, the president said in the interview.

On Hold

The FOMC left interest rates unchanged on Wednesday after raising them three times in the last three quarters. Policy makers penciled in one more rate hike in 2017 and three more in 2018 in forecasts released in June. Those projections will be updated at their September meeting.

Yellen told lawmakers earlier this month that the Fed remained on course for further gradual increases in interest rates -- an intention reaffirmed Wednesday in the FOMC statement. However, she said those plans were contingent on continued confidence that the Fed will eventually achieve its 2 percent inflation goal.

After briefly poking above that level in February, inflation has fallen back down and stood at 1.4 percent in the 12 months through May, according to the Fed’s preferred price gauge.

Policy makers acknowledged the recent drop in inflation in their statement, while saying they still expected it to stabilize around their 2 percent objective in the medium term.

“We don’t sense a significant loss of confidence from the FOMC that inflation will return to target over time,” Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. wrote in a note to clients.

He said he expects the Fed to push ahead with its balance-sheet plans in September and line up a rate increase for December. That would just be a couple of months before Yellen’s term as head of the politically independent central bank expires, unless she’s renominated by Trump.

Julia Coronado, president of MacroPolicy Perspectives LLC in New York, agreed with that timetable. “The baseline will be to start the balance-sheet runoff in September and pause on rates; and hike again in December if all goes well,” she said.

But if the government runs into a debt ceiling problems, the FOMC could “tactically defer to November” to start reducing its big bond holdings, she said.

— With assistance by Christopher Condon, Craig Torres, and Jeanna Smialek

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