The FOMC completed their September meeting, with an outcome of no interest rate policy change as expected, but there was something a little different to announce. This was a more ‘important’ meeting, being one of the four per year that features a post-meeting press conference and Q&A session, used to clarify and fine-tune policy (which isn’t always crystal clear in the formal releases).
In the released statement, economic activity was described as having risen moderately this year, with solid job gains and low unemployment. Additionally, household spending shows moderate expansion with business capex having ‘picked up’ in recent quarters. Despite near-term challenges, the Fed noted that recent hurricanes are unlikely to alter the course of the broader national economy over the medium-term, aside from shorter-term inflation challenges from items such as gasoline.
The new item was the introduction of the balance sheet normalization program. What is that? As a backdrop, after the Fed completed the various rounds of quantitative easing years ago, where they had been actively buying treasury and agency mortgage bonds directly to keep yields low in those markets, they continued to reinvest proceeds of maturing bonds in order to keep stimulus from ‘trailing off’ too much, so to speak. The balance sheet is now $4.5 trillion in size, far larger than historical norms. To turn the stimulus faucet off completely and start reversing the build-up, it could require the significant selling of bonds held on its balance sheet, which could be disruptive to markets in large amounts by driving down prices and, hence, yields up. The other option—the one they’ve chosen to use—is letting maturities ‘roll off’ gradually by capping the amount of proceeds they’ll keep reinvesting.
This process is designed to not result in a large degree of market disruption—done by keeping the amounts limited and expectations for this normalization to be done over a long period of time, from $10 billion/month to start, and ramping this up over time. The assumption, based on statistics from the treasury and outside managers, is about 0.25-0.50% in upward yield drift ultimately. Today’s announcement was just the first step in a stimulus unwinding process, but it has to happen sometime. And, with the economy looking stronger, now is as good a time as any. Importantly, clearing space on the balance sheet could allow the Fed to again provide more stimulus down the road when we are faced with another slowdown, although, hopefully the amounts needed would be far less than during the years of the Great Recession, when stimulus spending was unprecedented.
The ‘dashboard’ of key data reflects few changes from recent meetings: