MNI INTERVIEW: No Need to Taper Runoff Caps -Fed Economist

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve won't necessarily reduce the amount

of securities shed from its portfolio each month prior to calling a halt to its

balance sheet reduction plan later this year, Philadelphia Fed economist Roc

Armenter told MNI.

     That could surprise some investors who are expecting the Fed to gradually

slow its monthly runoffs as it nears the end of balance sheet normalization - in

the same way it ramped up runoffs at the start of the process in 2017.

     But Armenter, who is among the staff economists working on the Fed's plans

to end balance sheet normalization, said doing so would unnecessarily complicate

things. And rolloffs, running at between $30 billion and $40 billion a month,

are already below the $50 billion limit.

     "If we're able to provide communications well in advance, we really don't

need to do reverse tapering of the caps," Armenter said. "That's more

complicated than just being able to announce ahead of time we'll stop at that

particular date."

     --END-DATE DEBATE

     Fed officials are close to announcing a plan to stabilize the size of their

balance sheet but the exact end-date for asset redemptions is still up for

debate, Armenter said.

     "The idea is to do it some time later this year," he said. "There is also

the intention of resolving what 'later this year' really means as soon as

possible. I expect there will be a discussion in upcoming meetings about this."

     The ultimate resting size of the balance sheet will be driven by demand for

bank reserves, now much higher than prior to the financial crisis, but the

minimum level needed to avoid excess volatility in rates markets is unclear.

Officials consider the best available estimate of minimum reserves to be roughly

$1 trillion, compared to the current $1.6 trillion, but also want to build in a

substantial buffer to cover fluctuations in demand.

     --FINAL DESCENT

     After ending runoffs, the Fed could keep total liabilities constant and

allow organic growth of currency and other nonreserve liabilities to whittle

down the reserves pool at a much slower rate as officials feel their way to the

final "new normal" balance sheet.

     The amount of U.S. dollars in circulation is expected to expand by roughly

$150 billion a year, while the Treasury general account and foreign repos, much

smaller liabilities categories, could grow in line with GDP.

     Effectively that would mean decelerating to a quarter of the current pace

of balance sheet reduction while officials monitor fed funds and other

short-term rates markets for signs of unwarranted tightening in financial

conditions, Armenter said.

     "By going slowly, we are able to probe a little bit further what is the

level of efficient and effective reserves," he said. "We are able to brake more

smoothly."

     Meanwhile, the Fed has still other decisions to make, including updating

its reinvestment plan for when it eventually needs to start purchasing assets

again to maintain the balance sheet's size. Buying bills to shorten the average

maturity of its Treasuries holdings could offer added flexibility in the event

the Fed needs to change investments quickly, Armenter noted.

     The Fed is also expected to continue allowing mortgage-backed securities to

roll off after the balance sheet reduction process is over in an effort to meet

its goal of holding primarily Treasuries in the long run, but officials will

have to decide whether to sell MBS outright to hasten the process.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]