MNI PRE-FOMC: Fed Faces Crossroads on 'Patient' Guidance

--Expectation "Patient" Could Be Added To Statement

--But Some Fed Officials Want To Move Away From Forward Guidance

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve faces investor expectations it will

provide reassurance at this week's meeting that it is taking weakening global

growth and business sentiment seriously, but such a move could run counter to

its longer-term goal of phasing out explicit signals about the future direction

of interest rates.

     The addition to its statement of "patient", a word repeatedly invoked by

Chair Jay Powell and other senior officials amid asset price turbulence, is

widely anticipated and would likely be understood by investors as a commitment

to keep rates on hold for the first half of the year. Failure to include it

might risk disappointing markets which have rebounded sharply in January.

     But, at the same time, policymakers have sought to convey a more flexible

approach in responding to changing economic circumstances by moving away from

explicit forward guidance, a crisis-era tool. Some officials have called for

abandoning existing statement language that "further gradual increases" in rates

would be consistent with economic objectives.

     Any modification to rates guidance could dictate expectations through the

May meeting.

     Separately, the FOMC's Wednesday meeting is expected to continue grappling

with issues related to the Fed's policy implementation framework, with direct

implications for the ultimate size of its shrinking balance sheet.

     Officials appear to be in broad agreement that keeping policy steady for

the next few months would allow them to assess how the economy is responding to

higher rates at a time when trade tensions are contributing to a slowdown in

global growth and after the prolonged U.S. government shutdown eroded

confidence.

     Powell has repeatedly emphasized that the Fed has the ability to be

"patient" as it waits to see how the economy evolves. The FOMC raised interest

rates four times last year to a target range of 2.25% to 2.5%, just below the

range of estimates of their neutral setting.

     Now, with a relatively healthy economy and inflation likely restrained by

housing-market pressures, the FOMC can afford to take a breather.

     --BALANCE SHEET

     The Committee is also in the midst of intensive discussions over how to

determine the long-run size of its balance sheet while still maintaining full

control over its benchmark interest rate. The exercise is viewed internally as

technical, but given the renewed spotlight on its balance sheet normalization

program, any suggestion of an earlier-than-expected end to runoffs will command

market attention.

     While they were content to ignore the program in its early stages,

investors are now questioning whether it is having an unintended negative impact

on liquidity.

     Powell and others have defended the runoff as operating smoothly and

serving its purpose, but they have pledged to reconsider its scope should

conditions warrant.

     In the normalization plan set out in June 2017, the FOMC said its portfolio

"will continue to decline in a gradual and predictable manner until the

Committee judges that the Federal Reserve is holding no more securities than

necessary to implement monetary policy efficiently and effectively."

     Officials have noted that when the balance sheet has shrunk past a certain

level, reserve scarcity is likely to generate upward volatility in the fed funds

rate -- an outcome officials want to avoid. But precisely which level of

reserves would produce volatility remains a subject of ongoing analysis.

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

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