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--Minimum Fed Reserves To Cap Volatility May Be $1-1.3 Trillion Plus Buffer,
Harker Says 
--Once Decision On Reserves Level Taken, Fed Will Consider Balance Sheet
Composition
By Jean Yung
     PHILADELPHIA (MNI) - The Federal Reserve is close to announcing an end date
for its balance sheet reduction program and will decide on the composition of
its securities portfolio afterwards, Philadelphia Fed President Pat Harker told
MNI late Wednesday.
     The Fed plans to target the minimum quantity of bank reserves needed to cap
volatility in short-term money markets, a figure Harker estimates to be in the
$1 trillion to $1.3 trillion range, plus a buffer to cover fluctuations in
non-reserve liabilities that can exceed $100 billion monthly.
     With reserves currently at $1.6 trillion and shrinking by up to $50 billion
a month, the wind-down may need to end as soon as this year, according to MNI
calculations, leaving the Fed with a much larger balance sheet than prior to the
financial crisis.
     "Once we make that decision (on the level of reserves), and that decision
should happen at some point in the relatively near future, then we can take some
time to think about the composition of the balance sheet," he said.
     --MAKE FEW WAVES
     Whether the Fed will taper the pace of runoff as it nears the end of
balance sheet normalization is still under debate, but the ultimate goal is to
bring the process to an end without making waves, Harker said.
     "I said a while ago it's like watching paint dry and I want to get back to
that," he said.
     "The idea of settling at a number slightly above what we think the ultimate
level is, and letting currency grow into it, that's a reasonable idea because we
don't know what precisely the number is," Harker said.
     The normalization principles suggest the Fed will eventually shift to a
portfolio primarily of Treasuries, but officials continue to debate how quickly
they should shed $1.6 trillion worth of mortgage-backed securities, Harker said.
     Another debate centers on the duration of the Fed's Treasury holdings.
Operation Twist in 2011 saw the Fed selling short-term securities and buying
longer-term bonds in an effort to lower longer-term interest rates. Now it holds
$2.2 trillion in notes and bonds but no bills.
     --REVERSE TWIST?
     Analysts have suggested that a shorter duration portfolio would allow the
Fed to extend duration as a way of adding monetary easing in a recession.
     "Do we reverse Operation Twist? If we do, how do we do it?" Harker said.
     The Fed can figure it out slowly and communicate its rationale well, he
said. "We have to communicate early and often and I'm confident we'll do that."
     Harker pushed back against the notion popular among some investors that the
Fed's so-called "quantitative tightening" campaign has played a role in recent
market volatility.
     If QT was causing unexpected financial tightening, yields of longer-term
securities would rise and instead they have fallen a little, he said.
     "Symmetry doesn't hold" when comparing QT and the Fed's crisis-era asset
purchases, he argued. Whereas quantitative easing worked in part through a
signaling effect about future policy -- namely by signaling the Fed intended to
hold rates lower for longer -- QT does not have a similar effect, he said.
     The balance sheet remains a passive tool, even as the FOMC last month
signaled openness to adjust the pace of normalization if necessary.
     Harker said the revised guidance marked little change from the FOMC's
stance that the fed funds rate is its primary means of adjusting policy.
     "In extraordinary circumstances, we should have every tool at our
disposal," including the balance sheet, he said. "That doesn't mean we'll use
it."
--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com
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