Stop Worrying About the Fed’s Balance Sheet
It’s not the threat that people seem to think it is.
Financial types have long had a preoccupation: What will the Federal Reserve do with all the fixed income securities it purchased to help the U.S. economy recover from the last recession? The Fed’s efforts to shrink its holdings have been blamed for various ills, including December’s stock-market swoon. And any new nuance of policy — such as last week’s statement on “balance sheet normalization” — is seen as a really big deal.
I’m amazed and baffled by this. It gets much more attention than it deserves.
Let’s start with the stock market. Yes, it’s true that stock prices declined at a time when the Fed was allowing its holdings of Treasury and mortgage-backed securities to run off at a rate of up to $50 billion a month. But the balance sheet contraction had been underway for more than a year, without any modifications or mid-course corrections. Thus, this should have been fully discounted.
Moreover, if anything, the run-off of the Fed’s balance sheet had a smaller-than-expected impact on the yields of those securities. Longer-term Treasury yields remained low, and the spread between them and the yields on agency mortgage-backed securities didn’t change much. It’s hard to see how the normalization of the Fed’s balance sheet tightened financial conditions in a way that would have weighed significantly on stock prices.
Better explanations for this fall’s weakness in the equity market abound. For one, economic growth and corporate profits looked set to falter in 2019, as the effects of corporate tax cuts waned and the labor market tightened. Demand for scarce labor should increase its share of income, crimping profits. And if the economy didn’t slow enough on its own, the Fed was likely to raise interest rates to make sure that happened. These developments weren’t good for an equity market that had been accustomed to strong earnings growth and an accommodative central bank.
Why then, one might ask, did the Fed announce changes to its plans to pare down its holdings of Treasury and mortgage-backed securities? Actually, there wasn’t much of a change at all. Here’s what Chairman Jay Powell said at his news conference last week:
The Fed will maintain a balance sheet big enough to satisfy banks’ demand for reserves, with a buffer above that so the Fed will not have to intervene in the money markets on a day-to-day basis;
The Fed now expects banks to demand more reserves than previously thought, so its balance sheet will likely be larger — this means more securities in its portfolio;
The Fed could use its balance sheet more actively as a monetary policy tool but only if interest-rate adjustments — its primary tool — were to prove inadequate.
None of this should be a surprise. It always was likely that the Fed would maintain the current “floor” system, in which its choice of the interest rate it pays on reserves drives monetary policy. It also has been clear that banks would have a greater demand for reserves than in prior expansions. That’s because the central bank now pays interest on those reserves, and post-crisis regulations require banks to keep a lot more cash and other liquid assets on hand.
rest at link
https://www.bloomberg.com/opinion/articles/2019-02-05/stop-worrying-about-the-fed-s-balance-sheet
for a moar balanced look at this see this
https://www.zerohedge.com/news/2019-02-05/feds-dudley-explains-how-i-learned-stop-worrying-love-feds-balance-sheet
The FRB muppets out in full force today.
https://www.zerohedge.com/news/2019-02-05/feds-dudley-explains-how-i-learned-stop-worrying-love-feds-balance-sheet