Minutes of the Federal Reserve's latest meeting show talk of paring bond holdings

By Martin Crutsinger
AP Economics Writer

WASHINGTON (AP) — Federal Reserve officials last month discussed the possibility of reducing their enormous portfolio of bond holdings later this year, sooner than many investors have been expecting.

The Fed’s bond holdings have kept downward pressure on interest rates. If its policy committee chose to start reducing those holdings, even at a likely gradual pace, it could lead eventually to higher rates on many consumer and business loans.

Concern about that possibility contributed to a selloff of stocks last Wednesday afternoon after the minutes of the Fed’s March meeting were released.

The minutes showed that Fed officials received a staff briefing on managing its $4.5 trillion bond portfolio. That portfolio has risen four-fold since the financial crisis erupted in 2008 as the Fed has taken extraordinary steps to keep long-term rates low to support economic growth.

No decisions about the bond holdings were made at last month’s meeting, at which the Fed announced a modest increase in its benchmark short-term rate. But the minutes indicated a general view among Fed officials that if the economy remained solid as expected, a change in their policy of keeping the holdings unchanged “would likely be appropriate later this year.”

“The FOMC minutes were clear that officials are contemplating beginning to address the balance sheet,” said Win Thin, an economist at Brown Brothers Harriman.

Paul Ashworth, chief U.S. economist at Capital Economics, said he thought any reduction in the Fed’s bond holdings wouldn’t occur until December. By then, Ashworth thinks the Fed will have raised its benchmark rate three more times.

The minutes said one approach for reducing the holdings that was discussed would be to suspend the reinvestment of at least some of the holdings of Treasury bonds and mortgage-backed securities as they mature. The Fed has been reinvesting those maturing bonds to keep from shrinking its holdings and thereby exerting upward pressure on long-term rates.

“Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner,” the minutes said. It added that any decisions should be conveyed to markets before being implemented.

At the end of March, William Dudley, president of the Fed’s regional bank in New York, suggested in an interview on Bloomberg television that the Fed might decide to take a pause in raising its key short-term rate once it begins trimming its bond holdings.

The Fed has been keeping the level of its balance sheet steady at $4.5 trillion, compared with less than $1 trillion before the financial crisis. Financial markets have been watching for any Fed signal on the timing of reductions in the bond holdings.

The minutes showed that Fed officials grappled during their discussions with two big uncertainties facing the U.S. economy: Whether it would be safe to let inflation rise faster for a while and how to assess the effects of President Donald Trump’s ambitious economic stimulus plans.

The rate increase the Fed announced last month was its second in three months.

There was less agreement over the issues of inflation and Trump’s economic plans. The minutes showed that several Fed officials thought Trump’s stimulus plans wouldn’t likely begin before next year.

The minutes said that because of the “substantial uncertainties” about the outlines of the program that might eventually emerge from Congress, about half the Fed officials had included no assumptions about Trump’s efforts in their economic forecasts.

Most believed Trump’s plans had the potential to boost growth. But some said there were also downside risks from a possible adverse economic reaction resulting from Trump’s measures to limit immigration and increase trade barriers to protect American workers.

The expectation of tax cuts and deregulation has sent stock prices rising since Trump’s November election victory. The minutes showed that the rise in stock prices was discussed by Fed officials, with some viewing the price level as “quite high relative to standard valuation measures” for stock prices.

On inflation, the minutes showed that some officials worried that if unemployment, now at a low 4.7 percent, fell further, it could pose a “significant upside risk” of higher inflation. The Fed’s dual mandates are to achieve maximum employment and moderate inflation. Unemployment is already below the Fed’s 4.8 percent goal, while inflation has remained below its 2 percent inflation goal for several years.

Some Fed officials thought the inflation target might be achieved by year’s end. Others argued that since inflation had run below 2 percent for so long, it would do no harm to allow prices to rise above 2 percent for a time.

The Fed’s decision to boost its key policy rate by a quarter-point in March left it in a range of 0.75 percent to 1 percent. The Fed continued to signal that it expects to raise rates a total of three times this year. Many economists have said they think rate increases will occur at the June and September meetings. The next meeting is May 2-3.