Market Brief – Sunday 3/10/19

On Friday, Federal Reserve Chair Jerome Powell gave a speech titled Monetary Policy: Normalization and the Road Ahead at the 2019 SIEPR Economic Summit in Stanford, California. He made some startling announcements in terms of the end of the Fed’s balance sheet unwind program.

The Committee is now well along in our discussions of a plan to conclude balance sheet runoff later this year. Once balance sheet runoff ends, we may, if appropriate, hold the size of the balance sheet constant for a time to allow reserves to very gradually decline to the desired level as other liabilities, such as currency, increase. We expect to announce further details of this plan reasonably soon.

There is no real precedent for the balance sheet normalization process, and we have adapted our approach along the way. In these final phases, we will adjust the details of our normalization plans if economic and financial conditions warrant. After decisions regarding the size of the balance sheet have been made, we will turn to remaining issues, such as the ultimate maturity composition of the portfolio. The Committee has long stated that it intends to return to a portfolio consisting primarily of Treasury securities.

It is likely the Federal Open Market Committee will announce the end of its balance sheet unwinding program at its upcoming March meeting. It is likely the program will end somewhere between October and December, which is earlier than expected.

The Fed is bowing to pressure from Wall Street to end the program, even though various members of the FOMC have stated the balance sheet unwind program is not having any negative effects on the financial markets.

Wall Street will likely have a brief celebration of this plan, but as long as the balance sheet unwind continues, it will counteract the positive effects of this year’s corporate share buyback expectations.

While the Fed will still have a large pool of Mortgage-Backed Securities in their portfolio, they will seek to swap these for U.S. Treasury bonds. By holding Mortgage-Backed Securities the Fed was able to suppress market volatility, so swapping them at some point, should lead to heightened volatility.

Regardless of when the Fed ends the program, they will be unable to stop the next Recession. The monetary lags from the balance sheet unwind will persist over a two-year period.