It looks ugly for risk assets as it shrinks demand to fit constrained supply. Goldman:
BOTTOM LINE: The March FOMC minutes revealed some of the key parameters of the balance sheet reduction process, including that the monthly cap would likely be set at $95bn—split $60bn-$35bn between Treasury and mortgage-backed securities—and that the caps would be phased in “over a period of three months or modestly longer.” The minutes also indicated stronger than expected support for a 50bp increase in the funds rate target range at the March meeting that was dampened by uncertainty related to the war in Ukraine. The minutes also indicated that participants judged it appropriate to move towards a neutral policy position “expeditiously.”
1. As Chair Powell promised at the March press conference, the minutes revealed some of the key parameters of the balance sheet reduction process. The minutes noted that “participants generally agreed” that passive runoff with peak caps of $60bn per month for Treasury securities and $35bn for mortgage-backed securities— for a total of $95bn per month and roughly double the pace of last cycle’s runoff—would “likely be appropriate.” Participants also “generally agreed” that “the caps could be phased in over a period of three months or modestly longer” and that it would be appropriate to consider sales of MBS “after balance sheet runoff was well under way.” The minutes also noted that “most participants judged that it would be appropriate to redeem coupon securities up to the cap amount each month and to redeem Treasury bills in months when Treasury coupon principal payments were below the cap.” We continue to expect balance sheet runoff to be announced at the May FOMC meeting.
2. The FOMC raised the funds rate target range by 25bp at the March meeting, but the minutes showed that “many” participants preferred a larger 50bp increase, although “a number” of these participants judged a 25bp appropriate given the uncertainty related to the Russian invasion of Ukraine. “Many” participants noted that “one or more” 50bp hikes would be appropriate at upcoming meetings if inflation pressures remained elevated. Additionally, participants judged that ongoing increases in the policy rate were “fully warranted,” and that it would be appropriate to move the stance of monetary policy “toward a neutral posture expeditiously,” consistent with similar recent comments from the Fed leadership. These comments support our forecast that the FOMC will hike 50bp at both the May and June meetings and also present an upside risk to our forecast, namely that the FOMC could continue to hike in 50bp increments at subsequent meetings as well until it reaches its 2.25-2.5% estimate of neutral.
3. Participants stressed that inflation readings continued to “significantly exceed” the Committee’s long-run goal, and “some participants” noted that elevated inflation “had continued to broaden from goods into services.” “Some participants” warned that recent inflationary pressures “could affect future inflation dynamics.” The Fed staff’s near-term PCE forecast was “revised up considerably relative to January,” reflecting high import prices, strong wage growth, and longer-lasting price pressures from supply-demand imbalances. The staff expected headline PCE inflation to be 4% in 2022, 2.3% in 2023, and 2.1% in 2024. While “a few participants” noted that short-term inflation expectations were at record levels, “several other participants” argued that longer-term expectations remained anchored, which, “together with appropriate monetary policy and an eventual easing of supply constraints,” would allow inflation to return to the Committee’s longer-run goal. Both the staff and FOMC participants noted that the risks to their inflation projections were skewed to the upside, reflecting risks posed by continued supply-chain disruptions, rising energy prices, and higher inflation expectations.
4. The Fed staff’s forecast for economic growth was “weaker” than at the January meeting, reflecting drags from the war in Ukraine and tighter financial conditions. The staff expected 2022 GDP growth to “step down markedly” from its 2021 pace, rebound slightly in 2023 as supply disruptions moderated, and “slow further” in 2024 to a pace “in line with potential growth.” Participants also revised down their GDP growth forecasts for 2022, reflecting slowing inventory investment and drags from reduced fiscal support, tighter financial conditions, and the war in Ukraine. Participants noted that labor demand continued to exceed labor supply and contribute to broadening wage pressures. “A few participants” pointed to signs that “pandemic-related factors that had held back labor supply might be abating,” such as a higher participation rate among prime-age men in February. Both the staff and FOMC participants highlighted downside risks to growth, with potential drags from prolonged supply-chain disruptions, weaker consumer sentiment, higher energy prices, and a more protracted conflict in Ukraine.