MNI: Recession Could Force Fed To End QT Early - Ex Officials

A recession next year would force the Federal Reserve to consider slowing or stopping the run-down of its massive asset portfolio long before bank reserves approach their equilibrium level, though any decision to alter course would not be made lightly, former Fed officials and ex-staffers told MNI.

"Conceivably sometime in 2023 they'll need to cut rates, so it’s quite plausible that economic circumstances could also raise questions about what to do with the QT program," former Atlanta Fed President Dennis Lockhart said in an interview.

"They’re reluctant to pause that normalization process or reverse it prematurely if that can be avoided," he said. "The first principle for rates and balance sheet policy is to avoid inconsistency."

RECESSION PREDICTIONS

Markets are pricing in a first quarter-point cut for the Fed's benchmark overnight rate by July 2023 after it peaks at 3.4% in February, and a second cut by December 2023. The fed funds rate is currently trading in a 2.25%-2.5% target range.

"The Fed's QT program could end by late next year, and it would easily be in the cards if the economy slows enough, even if the Fed isn’t reducing the funds rate," Ellen Meade, a former senior adviser at the Fed board now at Duke University told MNI.

If the FOMC were to cut rates before ending QT, it "would be blowing up ordering and messaging it took great pains to create, although that doesn’t mean it couldn’t happen," she said.

But if the economy were to slow below-trend without entering recession, "they’re more likely to leave rates unchanged. And if they’re doing that, their inclination would be to continue QT," said Bill Nelson, chief economist with the Bank Policy Institute and a former deputy director of monetary affairs at the Fed Board.

He judged that even in a mild recession the Fed could just hold rates steady and allow QT to continue.

TREASURY MARKET

A 2023 conclusion to QT would leave the Fed with a much larger balance sheet than desired, shaving just a little over USD500 billion from the current USD3.3 trillion of bank reserves, according to the New York Fed's May projections.

That's significantly above estimates of the minimum comfortable level of cash needed in the banking system, but investors and former policymakers worry that QT could still prompt periods of disruptions in funding markets amid concerns over worsening bond market liquidity.

"If market conditions really deteriorated a lot, I could imagine they could say okay, we're going to throttle back on QT, but I think it would take a lot," said William English, former director of monetary affairs at the Fed Board and secretary to the FOMC.

"The Fed would like very much to not have QT on the agenda and have to talk about it and make ongoing adjustments and so on."