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Fed Minutes Show Balance Sheet Will Begin Shrinking, 50-Basis Point Hikes Highly Likely

CalendarApril 6, 2022
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Karl Schamotta, Chief Market Strategist, karl.schamotta@corpay.com

The Federal Reserve’s unprecedentedly-large balance sheet is likely to begin shrinking in May. Minutes taken during the central bank’s March meeting show policymakers are close to finalizing a plan that would allow up to $95 billion in assets to roll off each month, including $60 billion in Treasuries and $35 billion in agency mortgage-backed securities.

No new estimates were provided on how the runoff might impact financial conditions, although Chair Jerome Powell said the change “might be the equivalent of another rate increase,” during the post-decision press conference.

Members also debated hiking rates more aggressively. Many favoured a 50-basis point move at the March meeting, but facing “greater near-term uncertainty associated with Russia's invasion of Ukraine,” opted for a smaller increase. “Many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings.”

The discussion came as unemployment dropped toward pre-pandemic lows, and as already-elevated inflation rates - exacerbated by the war in Ukraine - continued to climb. According to the minutes, “Some participants noted that elevated inflation had continued to broaden from goods into services, especially rents, and into sectors that had not yet experienced large price increases, such as education, apparel, and health care”. “A few participants judged that, at the current juncture, a significant risk facing the Committee was that elevated inflation and inflation expectations could become entrenched if the public began to question the Committee's resolve to adjust the stance of policy as appropriate to achieve the Committee's 2 percent longer-run objective for inflation”.

But with markets braced for tightening, post-release reaction has been relatively positive. 10-year Treasury yields dropped to 2.57 percent after climbing above 2.6 percent yesterday when governor Lael Brainard - long thought to be one of the more dovish members of the Fed’s rate-setting committee - said, “It is of paramount importance to get inflation down… Accordingly, the committee will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.”

The dollar is trading on a softer footing after hitting post-pandemic highs earlier in the week.

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