Fed Chairman Powell Talks Balance Sheet Runoff, Digital Dollar And Other Observations

The Fed concluded their second FOMC meeting of the year on March 19^th.

The official Policy Statement contained two Policy Decisions:

1. The Fed will maintain the Fed Funds Rate at the target range of 5.25% to 5.50%
2. The Fed will continue reducing holdings of its Treasury securities and MBS as previously announced.

The Fed has maintained this target range of Fed Funds since July 2023, and has not made any adjustments for five consecutive FOMC meetings.

In addition, the Fed initiated their balance sheet reduction policy in May 2022, and has not made an adjustment for fifteen consecutive FOMC meetings.

Following the end of the FOMC meeting and the release of the Policy Statement, Fed Chairman Powell held a press conference to provide a bit more insight to the Fed’s thinking and to answer questions from the press.

The Fed also released their updated Summary of Economic Projections (SEP) to provide more guidance as to their thinking. The SEP lists what each of the 19 members of the FOMC expects for the next few years. It covers economic growth, the unemployment rate, inflation and interest rates. Importantly, only 12 of the 19 FOMC members vote on policy.

Below are my key takeaways:

Fed Funds Rate

The primary focus of the market is on what is going to happen to the Fed Funds Rate. This is the most useful tool in the Fed’s monetary policy tool box, and therefore carries significant weight.

Thirteen of the eighteen questions posed to Chairman Powell were in one form or another, trying to glean movement and timing of a change in the Fed Funds Rate.

The questions covered the primary economic indicators of inflation, employment and strength of the economy to gain insight.

What is fascinating is what Powell says compared with how his statements are interpreted by the market. They do not always align.

What Powell Said:

“The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American People. We are strongly committed to returning inflation to our 2.0% objective.”

“We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year.”

“We know that reducing policy restraint too soon or too much could result in a reversal of the progress we have seen on inflation and ultimately require even tighter policy to get inflation back to 2.0%. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably down toward 2.0%”

“If the economy evolves as projected, the median participant projects that the appropriate level of the Federal Funds Rate will be 4.6% at the end of this year, 3.9% at the end of 2025 and 3.1% at the end of 2026.”

“We make decisions meeting to meeting…(will) depend on our ongoing assessment of the incoming data, the evolving outlook and the balance of risks.”

“the Committee wants to see more data that gives us higher confidence that inflation is moving down sustainably to 2.0%….we don’t see this data now.”

“We’ve got nine months of 2.5% inflation now and we’ve had two months of kind of bumpy inflation…The question is; are they more than bumps? And we just don’t know that.”

Market Interpretation:

The market interpreted Powell’s comments as dovish with both stocks and bonds rallying on the news. Stocks even set new all-time highs.

Balance Sheet Runoff

In the press release, following the FOMC meeting, the Fed announced that they would continue with reducing their holdings of Treasury securities and MBS, following previously announced plans.

In his opening remarks, Powell indicated that Committee discussed slowing the pace of the balance sheet runoff, and he stated that the slowdown would begin fairly soon. He was clear that slowing the pace of the balance sheet reduction would not affect the ultimate end point of the runoff. It would, however, prevent stress in the money markets as the Fed approaches the appropriate level of ample reserves.

In the Press Conference that followed, three questions were asked about the balance sheet. This was the largest number of questions since the Fed began Quantitative Tightening (QT) two years ago.

In the Q & A Powell revealed that the slower pace would only apply to Treasury securities. That is because MBS are already running off at less than the Fed’s Target rate. While the Fed’s long-term goal is to hold an all-Treasury securities portfolio, that is not the focus now.

Powell alluded to the Fed’s last attempt at QT in 2019. He said “by going slower you can get farther.” By that he meant by slowing the pace of runoffs the Fed will encounter less risk of the kind of liquidity problems they had in 2019, which caused the process of QT to end prematurely.

In mid-September 2019 overnight money market rates spiked to almost 10% amid an imbalance in liquidity and a large drop in reserves. In response, the Fed reversed course, ending QT and buying Treasury bills to rebuild reserves.

Powell indicated that liquidity is not always evenly distributed in the system. While overall reserves can be ample, or even abundant, there could be banks where this is not the case, which can cause stress. By moving slowly as the Fed nears the endpoint of QT, they are more able to manage this situation.

Central Bank Digital Currency

On the more unusual side, for the first time Powell was asked about what the Fed was doing with regard to a Digital Dollar, given that there were some rumblings in Congress that the Fed was exploring this issue.

Powell was quick to shoot down that idea. The Fed has not proposed, nor was it considering proposing, that Congress initiate legislation to authorize a Digital Dollar.

He did concede, however, that the Fed was trying to stay on the forefront of what is going on in digital finance, particularly with regard to digital payment systems. He emphasized that the Fed was not working on a Central Bank Digital Currency, but that they were trying to increase their understanding of the concept.

Conclusion

Chairman Powell has been quite consistent with his statements since QT began. The Fed is focused on their mandate of maximum employment and stable prices. Employment has been strong, and while inflation has been coming down, it has been bumpy, and is still elevated above the desired goal of 2.0%.

The Fed needs to see convincing evidence to be confident that inflation is moving sustainably down to 2.0%.

While the market’s interpretation has been that Powell’s recent comments are dovish, it may find that the Fed will show more patience than expected until they have the confidence that they are looking for to act.