MNI: Ukraine War May Dampen Fed’s QT Appetite – Ex-Staffers

Federal Reserve policymakers may be less inclined to take swift or aggressive action to reduce the central bank’s USD8.9 trillion balance sheet as the war in Ukraine raises risks to the financial system and strains some markets, former Fed staffers tell MNI.

While the situation in the Ukraine could change, the Fed could choose to push back moves to run down the balance sheet by a couple of months, or potentially kick it off in smaller increments if market disruptions deepen, the former staffers said.

“I was about to say they'll start reducing the size of the balance sheet by June, but I'm not quite positive because of the Russia/Ukraine stuff – that creates real uncertainty,” said William English, former director of the division of monetary affairs at the Fed Board, now at Yale University.

“Maybe markets could come under a lot of stress from that and they may just figure it would be better to not put on top of that the start of the reduction in the size of the portfolio."

Before the conflict, the Fed had signaled that it would like to begin trimming its asset holdings, which doubled during the pandemic as officials ramped up bond buys, as early as this spring. Some officials argued for fairly rapid rundowns, totaling as much as USD100 billion per month, and possible asset sales of mortgage-backed bonds.

UNCERTAINTY

That fervor may be dampened by the market volatility and associated uncertainty surrounding sanctions aimed at kicking Russia out of the global financial system, which increased risks and led to a sharp increase in commodity and oil prices.

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“Both in terms of clarity of communication, they don't want to confuse people by starting to roll things off the balance sheet now when their plan has always been to wait at least when they’ve gotten rates up towards normal before they start normalizing their balance sheet,” said Jeff Fuhrer, a former senior economist and policy adviser at the Boston Fed.

“Now that means they’re likely to be waiting even longer. Whatever their plan was before this I can’t see them pushing for it just because it was a plan. That’s going to slow them down and make them more fearful both of market reaction and the fundamental soundness of doing some tightening through balance sheet reduction.”

TESTING MARKET RESILIENCE

While there have been no signs of strains in the Treasury market, any liquidity issues of the sort seen in late 2019 or early 2020 could cause policymakers to temporarily hit the brakes on any tightening push, particularly when it relates to balance sheet drawdowns.

“If you think that there are some structural issues in the Treasury market and that those may lead to diminished liquidity in a period of stress then you certainly don't want to add to stress via what you’re doing,” said Richard Berner, former director of Treasury Office of Financial Research now at NYU Stern.

“It’s pretty clear there’s been talk in the FOMC minutes about selling MBS. Would you do that in a period of stress? Probably not.”

That doesn’t mean the Fed will be discouraged from pursuing QT altogether.

"When there's uncertainty, when you're in a dark room trying to feel your way, you move slowly. But that doesn't mean you stop,” said Alan Detmeister, who formerly led the Federal Reserve Board’s wage and price section and is now an economist at UBS. “On QT, you get started but maybe you start with a little bit lower cap and then just be very cautious on ramping it up.”