Fed Members Back Faster Rate Hikes, 'Significant' Balance Sheet Reduction: Minutes

By Yasin Ebrahim

Investing.com -- Federal Reserve officials were in favor of reining in accommodative monetary policy measures with a faster pace of rate increases and a "significant" reduction in the size of balance sheet that could begin later this year, the Fed’s January meeting minutes showed Wednesday. 

"With inflation well above 2 percent and a strong labor market, members expected that it would soon be appropriate to raise the target range for the federal funds rate," according to the minutes.  

The faster pace of rate hikes, however, is conditional on whether the pace of inflation continues to trend above target or eventually dissipates.       

"Most participants noted that, if inflation does not move down as they expect, it would be appropriate for the Committee to remove policy accommodation at a faster pace than they currently anticipate," the minutes showed. 

The odds of a 50 basis point rate hike at the Fed's meeting has eased slightly to about 50%, 25% last week, according to Investing.com’s the Fed rate monitor tool.

On the balance sheet, fed members noted that "a significant reduction" in the size of the balance sheet would likely be appropriate, which could get underway "sometime later this year." 

Following its previous Jan. 25-26 meeting, the Federal Open Market Committee kept its benchmark rate in a range of 0% to 0.25%, but teed up the prospect of increasing interest rates at its next meeting in March.

In his press conference following the monetary policy statement, Federal Reserve Chairman Jerome Powell stoked fears of aggressive Fed rate hikes, saying there was "quite a bit of room to raise rates without hurting jobs."

Since the meeting in January, inflation has continued to trend well above the Fed’s 2% target, the labor market is inching closer to maximum employment, and the once low prospect of a 50 basis point rate hike is being priced in.

The St. Louis Fed president, who tends to lean more hawkish on monetary policy, has been one of the more audible members among his peers calling for aggressive Fed rate hikes.

“I’d like to see 100 basis points in the bag by July 1,” James Bullard said in an interview with Bloomberg. “I was already more hawkish but I have pulled up dramatically what I think the committee should do."

An increasing number of market participants, however, are bemused as to why the Fed, despite acknowledging concerns about elevated inflation, has continued to persist with its monthly bond purchases, albeit at a reduced pace of $30 billion a month.

Most fed members, however, preferred to continue to "reduce the committee's net asset purchases according to the schedule announced in December, bringing them to an end in early March," according to the minutes. 

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The U.S. central banks’ balance sheet has swelled to nearly $9 trillion. Previous attempts, however, to cut the size of its balance sheet, or engage in quantitative tightening, haven’t been well received in markets.

In 2018, the Fed allowed certain bonds to mature each month without reinvesting the principal of the bonds in new securities.

But the central bank was soon forced to halt the process in the latter part of 2019 after a key short-term overnight lending rate, which supports the plumbing of the financial system, surged and threatened the stability of funding markets.

Powell, however, believes today’s economy is on more of a solid footing, and likely able to cope better with quantitative tightening.