The Federal Reserve is expected to meet this week and make a big decision that could affect many things. On Wednesday, the central bank is expected to announce a reduction strategy in its $4.4 trillion balance sheet. Although there’s confidence within the bank that the move will go on smoothly, there is the risk of rattling the financial markets that have already become accustomed to the Fed’s monetary largesse.
During the recession and the financial crisis in 2007, 2008, and 2009, the Federal Reserve acquired massive amounts of treasury and mortgage bonds. The goal at the time was to push down long-term costs of borrowing. The strategy was also designed to act as a stimulus for the economy and the credit market that had already crumbled. Although there was opposition to the policy, it was largely implemented under the name “quantitative easing.”
The Fed’s policy has also been praised for helping in the efforts to restore the US economy growth and jumpstart the credit market towards a path of recovery. It’s because of this that the proposed reduction of the $4.4 trillion balance sheet has sent shivers down the spine of many experts on Wall Street. Federal Reserve officials have assured Wall Street that the reduction of the balance sheet will be done in a gradual manner. This way, the impact on the markets will remain minimal at best.
But there are some analysts on Wall Street who have a different perspective. While calling the Wednesday meeting as “the biggest meeting of the year,” the chief economist at Bank of the West, Scott Anderson, said in an email sent to reporters that the Federal Reserve was a bit sanguine on the impact that the reduction will have on the market. Anderson also added that he was uncomfortable with the possibility that policymakers at the Federal Reserve could hike interest rates three more times next year and in 2019.
Federal Reserve Chair Janet Yellen is expected to leave the central bank early next year once her term expires. Investors feel that this vacuum and change in leadership could add more uncertainty to the interest rate policy at the bank in the near future. Anderson argues that at the moment, although inflation has continually undershot the target set by the central bank, this is because the job market is not as stable as it appears even with a 4.4% unemployment rate.
Anderson also notes that the bond market is yet to fully normalize. He notes that the two-to-ten-year treasury spread has narrowed since the start of 2017 while inflation in the bond market has remained below the historical normalcy. According to Anderson, these factors suggest that perhaps it’s still too early for the Federal Reserve to start normalizing monetary conditions. Anderson is advising a go-slow approach where all risk factors are carefully analyzed. But Wednesday is big day and many people are waiting to see what the way forward will be.