The Federal Reserve may begin reducing its balance sheet as soon as its May 3-4 policy meeting to address the level of U.S. inflation that have become “particularly acute,” New York Fed chair John Williams said Saturday.
With Fed interest rate increases already underway, Williams, who also holds the title of vice chair of the board and is a permanent voter on the monetary policy committee, indicated that the central bank will now begin tightening financial conditions through a second channel by letting its nearly $9 trillion portfolio of Treasury bonds and mortgage backed securities decline each month. As the Fed’s stock of asset holdings decline, it puts upward pressure on Treasury bond yields and mortgage rates.
“This process of reducing the size of the balance sheet can begin as soon as the May (Federal Open Market Committee) meeting,” Williams said in remarks to a symposium at Princeton University’s Griswold Center for Economic Policy Studies, in New Jersey, CNBC reported.
He cited inflation running at 6.5%, more than triple the Fed’s 2% target, as the central bank’s “greatest challenge,” with inflation potentially driven higher by the war in Ukraine, the coronavirus pandemic, and labor and supply shortages.
“Uncertainty about the economic outlook remains extraordinarily high, and risks to the inflation outlook are particularly acute,” Williams said.
“Clearly, we need to get something more like normal or neutral, whatever that means,” he told the symposium on Saturday after delivering a speech, Bloomberg News reported. “Do we need to get there immediately? No. We can do this in a sequence of steps.”
The Fed increased its short-term federal funds rate in March by a quarter of a percentage point, and is expected to continue with rate increases at each of its six remaining meetings this year. The Fed published projections showing the median policy maker expected to lift rates to 1.9% by the end of the year and 2.8% at the end of 2023. The median forecast for the neutral rate, a theoretical level that neither speeds up nor slows down the economy, is 2.4%.
Some Fed officials have advocated larger half percentage point increases to further tighten credit. Williams did not address that issue in his prepared remarks, but has earlier said he would be open to the idea depending on how economic data evolve.
The consumer price index soared 7.9% in February, the most since 1982. The Fed’s 2% inflation target is based on a separate gauge, the personal consumption expenditures price index, which rose 6.4% in the 12 months through February.
“I anticipate inflation readings will begin to decline later this year, although this process will take time to fully play out,” Williams said. “For 2022 as a whole, I expect PCE inflation to be around 4%, then decline to about 2.5% in 2023, before returning close to our 2% longer-run goal in 2024.”
Williams, in response to questions at the symposium about whether the Fed needed to hasten its return to a neutral policy rate that neither encourages or discourages spending, noted that in 2019 with rates set near the neutral level “the economic expansion started to slow,” and the Fed resorted to rate cuts, Reuters reported.
“We need to get closer to neutral but we need to watch the whole way,” Williams said. “There is no question that is the direction we are moving. Exactly how quickly we do that depends on the circumstances.”