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Federal Reserve chairman Jerome Powell may have successfully managed the tricky feat of warning financial markets that the U.S. central bank would gradually end its current balance sheet expansion without creating undue volatility.
At his press conference Wednesday, following the Fed’s latest policy meeting, Powell emphasized that the Fed would maintain a level of purchases of assets that would keep up with the growth in currency circulation. Some market participants took this as guidance that U.S. Treasury bill purchases were unlikely to be terminated abruptly.
Since the crisis in U.S. term money markets last September, the Fed has purchased $60 billion of U.S. Treasury bills every month and carried out daily liquidity operations offering short-term funding to market participants to rebuild reserves in the banking system.
However, some analysts have criticized the Fed’s move as a form of quantitative easing such as the central bank employed in the wake of the 2008 financial crisis and claimed that the extra liquidity contributed to the recent rally in stocks to record prices.
At his Wednesday press conference Powell said the Fed would target a reserves level of no less than $1.5 trillion. Reserve balances held at the Fed stood at $1.74 trillion as of Jan. 15.
Based on Powell’s remarks, Pimco analysts said the bill-buying could gradually shrink to around $10 billion per month after April or May.
Powell’s even-keeled comments were probably aimed at deflecting fears of another “taper tantrum” that triggered a spike in U.S. Treasury yields in 2013 after investors learned that the Fed was slowly putting the breaks on its quantitative easing program.
Krishna Guha of Evercore ISI described Powell’s update on the balance sheet as gentle guidance to the market, telling investors not to expect a further substantial buildup of its around $4.2 trillion portfolio of Treasurys and mortgage-backed bonds.
Powell’s insistence that the Fed would only gradually move to a sustainable level of banking system reserves represents a change from back in December 2018 also when he said that the runoff of the Fed’s portfolio securities was on “autopilot” as part of its plan to normalize monetary policy.
Those seemingly innocuous comments sent U.S. stocks spiraling lower on worries that the Fed was ignoring Wall Street’s apprehension around a shrinking balance sheet which some saw described as “quantitative tightening.”
“My read is that the Fed is scared to death of a repeat of the September repo market episode and if it means maintaining a balance sheet that is hundreds of billions of dollars larger than what would be necessary on a normal day to avoid pressure at times of stress, then the Fed is willing to do so,” wrote Stephen Stanley, chief economist for Amherst Pierpont, in a Wednesday note.
Former New York Fed President William Dudley has said that central bank will have to endeavor to disabuse investors perception that a larger balance sheet was boosting asset prices.
“I have confidence Powell will have a good handle on this,” said George Boyan, President of Bank Leumi Investment Services.
In markets, the S&P 500 SPX, +0.31% and Dow Jones Industrial Average DJIA, +0.43% were down more than 1% this week on fears China’s coronavirus epidemic would disrupt travel and trade and slow global economic growth.
But the 10-year Treasury note yield TMUBMUSD10Y, +0.10% traded at 1.545% Thursday, slightly more than 20 basis points away from its all-time low of 1.32% set on June 2016 and Treasury bill rates were little changed by Powell’s guidance.
Also read: History suggests a downward trek for stocks when Fed stops buying T-bills, expert says
