April 11, 2017 - Fed Wants To Decrease Its $4.5 Trillion Balance Sheet
The Fed May Start to Cut a $4.5 Trillion Balance Sheet This Year, Minutes Show By The Street
Federal Reserve officials have finally started to discuss when they might shrink a balance sheet that swelled to $4.5 trillion as the central bank shored up the U.S. economy after the 2008 crisis, but they haven't firmly committed themselves to a timeline.
Presuming the economy continues to perform as the Fed's monetary policy committee expects, members indicated at a March meeting that the central bank would probably change later this year its policy of automatically reinvesting the proceeds of maturing securities, according to minutes of the session. Such a shift would pare the Fed's holdings over time.
"The debate surrounding the balance sheet is clearly heating up," Ryan Sweet, director of real time economics at Moody's, said in a phone interview after the minutes were released. "The Fed is clearly going to telegraph when they are going to make that change -- December seems like a logical time to do it."
How trimming the balance sheet might affect future increases to short-term interest rates, which haven't topped 1% since the financial crisis, is unclear. During its March meeting, the monetary policy committee boosted rates by 25 basis points, to a range of 0.75 to 1%, in only the third hike since 2008.
For now, committee members maintained their projection of two more hikes this year, which could take rates to a range of 1.25% to 1.5%.
But "if the Fed realizes that the balance sheet is affecting financial markets conditions more than they anticipated, they may back off rate hikes a little bit," Sweet said.
New York Fed President William Dudley, a permanent member of the monetary policy committee, already signaled the Fed's sentiment on shrinking its balance sheet -- which includes debt, mortgage-backed securities and Treasury notes -- in an interview in late March.
"It wouldn't surprise me if sometime later this year or sometime in 2018, should the economy perform in line with our expectations, that we will gradually start to let securities mature rather than reinvest them," he said in a Bloomberg interview. Reinvesting securities has kept interest rates lower by limiting the supply in the bond market.
"Reinvestments would most likely be phased out rather than stopped all at once," according to the minutes, which means the balance sheet would remain sizable for some time.
"The Fed halting the reinvestment of maturing bond holdings is only dipping a toe into the water of winding down a $4.5 trillion balance sheet," Greg McBride, Bankrate.com chief financial analyst, said in an e-mail. "Does anybody really think the Fed can meaningfully ratchet down a balance sheet of that size before the next economic slowdown comes along? It's very doubtful."
Another concern weighing on the Fed's decision-making, Sweet said, is that Fed Chair Janet Yellen's term expires in 2018. President Donald Trump, who criticized the Fed while campaigning, hasn't indicated whether he would reappoint her.
"For a smooth transition from a markets perspective, the Fed may want to put the balance sheet on relatively a preset course before Yellen's term ends," Sweet said. That task may prove even thornier with monetary policy committee members now speculating that meaning economic-stimulus efforts from Trump and his Republican allies won't begin until 2018.
The defeat last month of a proposal to replace Obamacare, supported by Trump, cast doubt on the president's ability to corral votes in a fractious Congress.
Even with such delays, the Fed was still relatively upbeat about the economy, according to minutes. Its decision to raise rates was underpinned in part by an improving labor market, reflected in ADP data Wednesday that showed 263,000 jobs were added in March.
The central bank didn't indicate when it might increase rates next, though the policy committee meets again on May 2. Minneapolis Fed President Neel Kashkari was the only committee member to vote against the most recent hike.
"To stay with the gradual mantra that the Fed's laid out, I think a rate hike in June would be consistent with that," Sweet said. "Going in May would kind of create a sense of urgency, which I think the Fed wants to avoid."
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What Are Bond Investments
Governments and companies may issue bonds to finance operations. Most companies can borrow from banks, but view direct borrowing from a bank as more restrictive and expensive than selling debt on the open market through a bond issue. There are different kind of bond investments issued from governments, corporations.
A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally, a short-term corporate bond has a maturity of less than five years, intermediate is five to 12 years and long term is more than 12 years.
A convertible bond may be redeemed for a predetermined amount of the company's equity at certain times during its life, usually at the discretion of the bondholder. Convertibles are sometimes called "CVs."
Callable bonds, also known as "redeemable bonds," can be redeemed by the issuer prior to maturity. Usually a premium is paid to the bond owner when the bond is called.
Term bonds are bonds from the same issue that share the same maturity dates. Term bonds that have a call feature can be redeemed at an earlier date than the other issued bonds. A call feature, or call provision, is an agreement that bond issuers make with buyers. This agreement is called an "indenture," which is the schedule and the price of redemptions, plus the maturity dates.
An amortized bond is a financial certificate that has been reduced in value for records on accounting statements. An amortized bond is treated as an asset, with the discount amount being amortized to interest expense over the life of the bond. If a bond is issued at a discount - that is, offered for sale below its par (face value) - the discount must either be treated as an expense or amortized as an asset.
Issued by a corporation during a restructuring phase, an adjustment bond is given to the bondholders of an outstanding bond issue prior to the restructuring. The debt obligation is consolidated and transferred from the outstanding bond issue to the adjustment bond. This process is effectively a recapitalization of the company's outstanding debt obligations, which is accomplished by adjusting the terms (such as interest rates and lengths to maturity) to increase the likelihood that the company will be able to meet its obligations.
A junk bond,also known as a "high-yield bond" or "speculative bond," is a bond rated "BB" or lower because of its high default risk. Junk bonds typically offer interest rates three to four percentage points higher than safer government issues.
Angel bonds are investment-grade bonds that pay a lower interest rate because of the issuing company's high credit rating. Angel bonds are the opposite of fallen angels, which are bonds that have been given a "junk" rating and are therefore much more risky.
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