Double-barreled Fed tightening is on the way
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After months of moving gingerly to withdraw monetary stimulus, the Federal Reserve's tightening campaign now looks set to enter a rapid new phase.
- That's the conclusion to draw from new minutes the central bank released Wednesday that spell out the Fed's plans. It aims to shrink its $9 trillion balance sheet nearly twice as fast as it did the last time it undertook "quantitative tightening" — while simultaneously raising short-term interest rates more quickly.
Why it matters: The trillions of dollars the Fed pumped into the financial markets through the pandemic lifted asset prices of all types. Its plans to reverse that process are part of a double-barreled tightening campaign, likely to begin in less than four weeks, that could have unpredictable effects across markets.
Minutes of the policy meeting that ended March 16 showed strong internal consensus around "quantitative tightening" — the reversal of "quantitative easing" policies, achieved by not replacing securities that mature — at a rate of up to $95 billion, compared with $50 billion in the last period of Q.T. that began in 2017.
- The actual numbers might end up below that level, as the Fed's portfolio of mortgage backed securities may not mature fast enough. The minutes said that the officials envision eventually selling those securities outright.
- They expect to phase in the tightening program over three months, "or modestly longer" if market conditions warrant, a process that could begin following a meeting that concludes May 4.
Make no mistake as to what is being described here. The Fed will soon be sucking up to $1.14 trillion a year out of the financial system. At the same time it will be steadily raising short-term interest rates, including, the minutes also strongly suggest, by half a percentage point at some meetings.
- Put together, that is a more rapid tightening of monetary policy than has been seen since the Paul Volcker era in the early 1980s. Of course, inflation is also the highest it has been since then, so, maybe that's not too surprising.
- That could cause problems across the economy, particularly in areas sensitive to credit conditions — like in the housing market or among highly-leveraged corporations.
The bottom line: The Fed has faced accusations of being behind the curve on tightening the money supply for months. Now we're going to find out what happens as it tries to catch up.
