A Hawkish Fed About to Embrace Rapid Balance Sheet Reduction? – Mish Talk

April 8, 2022

Image via Fox News Tweet, "Fed Won't Jolt the Market." — Image via Fox News Tweet, “Fed Won’t Jolt the Market.”

Hawkish Fed?

Bloomberg reports Hawkish Fed Sinks Tech Shares; Bonds Fall

“Another very hawkish readout indicates the Fed is willing to walk the walk,” Sean Bandazian, senior investment analyst for Cornerstone Wealth, said. “Aside from the pace of the balance sheet roll off, most telling from the minutes was the preparedness to hike 50 basis points last month.
“The Fed is going to be very aggressive going forward even if it has a negative impact on economic growth and the stock market,” Matt Maley, chief market strategist at Miller Tabak + Co., wrote in a note.

The CPI is up 7.9% year over year. The Fed could not even pull the trigger for a 50 basis point hike in March even after the futures briefly priced it in.

Balance Sheet Reduction

Let’s tune into the Minutes of the March 15-16 FOMC Meeting for the Fed’s discussion of interest rates and balance Sheet Reduction.

Minutes: All of the options featured a more rapid pace of balance sheet runoff than in the 2017–19 episode. The options differed primarily with respect to the size of the monthly caps for securities redemptions in the SOMA portfolio.

Mish: The Fed effectively stated “faster than snail” because that was the previous pace that never finished before the Fed started expanding again.

Minutes: Several participants remarked that they would be comfortable with relatively high monthly caps or no caps. Some other participants noted that monthly caps for Treasury securities should take into consideration potential risks to market functioning. Participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate.

Mish: The maximum paces is thus set at a total of $95 billion a month.

Minutes: Some participants noted that under the proposed approach to running off Treasury and agency securities primarily through adjustments to reinvestments, agency MBS holdings would still make up a sizable share of the Federal Reserve’s asset holdings for many years.

Mish: Many years is the new “fast”.

Minutes: Several participants noted the significant uncertainty around the future level of reserves that would be consistent with the Committee’s ample-reserves operating framework. Against this backdrop, participants generally agreed that it would be appropriate to first slow and then stop the decline in the size of the balance sheet when reserve balances were above the level the Committee judged to be consistent with ample reserves, thereby allowing reserves to decline more gradually as nonreserve liabilities increased over time.

Mish: How fast?

Minutes: Participants generally agreed that it was important for the Committee to be prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments.

Mish: The Fed is prepared to quickly back off the speed at which it reduces its balance sheet. Ok but how long will it take to get up to $95 billion a month speed?

Minutes: Participants also generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warrant.

Mish: This is a strong indication the Fed will not quickly start a huge balance sheet reduction. Rather, it will be phased in over three months or longer.

Again I Ask, Hawkish?

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The Fed meets in May, June, June and July so it could ramp up to $95 billion in three months.

Rest assured it will not be faster. Then what?

Minutes: Participants generally agreed that after balance sheet runoff was well under way, it will be appropriate to consider sales of agency MBS to enable suitable progress toward a longer-run SOMA portfolio composed primarily of Treasury securities. A Committee decision to implement a program of agency MBS sales would be announced well in advance.

Mish: Depending on the meaning of “well under way” and assuming the Fed has not already abandoned this idea due to a housing-led recession, the Fed will then and only then consider speeding up MBS sales, communicated “well in advance”.

Getting This Correct

In regards to Fed vice-chair Lael Brainard, DiMartinoBooth commented “Despite we saw the most dovish member turn hawk yesterday I think they will go slowly about this.“

Bingo. I laid out all of the details above.

Moreover, Brainard recently gave one of the most disingenuous Fed speeches ever, even mentioning Former Fed chairs Paul Volcker and Arthur Burns.

Arthur Burns noted in the late 1960s that “there can be little doubt that poor people…are the chief sufferers of inflation.”

Indeed. And what has this Fed done for the past two years but promote inflation?

Here’s the deal in a nutshell: The Fed actively promotes inflation while pretending to be inflation fighters. Yet, people listen to these clueless jackasses as if they know what they are doing.