While the financial world watches with baited breath each time the Federal Open Market Committee meets, constant debate arises amongst analysts and economists regarding whether the Federal Reserve will keep conditions the same or raise interest rates. The Fed has indeed increased the interest rate on three separate occasions since December of 2015 and more of them are anticipated before the end of this year. Obviously, the ultimate objective is to maintain a healthy economy for all Americans.
Many discussions omit the important topic of what the Fed intends to do with its immense portfolio of bonds. Currently valued at $4.5 trillion, economists believe that the central bank will reduce its portfolio in further efforts to support the economy’s health. The question remains: what impact will reducing the Fed’s portfolio have on monetary policy and rates? According to economists, nothing more than a modest one.
Approximately 55% of economists in a Wall Street Journal poll believe that the Fed reducing its balance sheet by allowing assets to mature will raise the yield on 10-year Treasury notes no more than 0.2%. Another 40% thought the impact would be practically negligible, increasing the yield up 0.1% or less.
Correspondingly, speaking to what impact a balance sheet reduction would have on monetary policy, economists believe it will be minor. To be specific, nearly 50% said it would have less of an impact than would raising key interest rates another 0.25%, which the Fed is expected to do at its policy meeting in June. An additional 20% stated they didn’t think the move would have any meaningful effect at all.
Though the Federal Open Market Committee is not one to disclose information prematurely, members of the board of governors have alluded to the fact that the Fed wants to begin the balance sheet reduction process soon, in an attempt to avoid any major disturbances to the global economy.
Officials are concerned that starting the reduction process too late could cause a so-called “taper tantrum”, though Stanley Fischer, Vice Chairman for the Fed, has commented that since the economy is in much better shape, a recurrence of 2013 is very doubtful. “We appear less likely to face major market disturbances now than we did in the case of the taper tantrum,” Fischer told the Wall Street Journal back in April. Experts feel that the next release of information about the balance sheet reduction is very likely to come after the June meeting.