The Federal Reserve will soon start growing its balance sheet again, a response in part to the jolt to overnight lending markets in September, Chairman Jerome Powell said Tuesday.
How the Fed will go about expanding the securities it holds will be explained in the coming days, though Treasury bill purchases will be involved, the central bank chief said during a speech in Denver, though Powell stressed the approach shouldn’t be confused with the quantitative easing done during and after the financial crisis.
“This is not QE. In no sense is this QE,” he said in a question and answer session after the speech.
On monetary policy more broadly, Powell stuck to his recent script: He and his fellow policymakers view the economy as being strong but susceptible to shocks, particularly from a global slowdown, trade and geopolitics like a potentially messy Brexit. He said the Fed stands committed to supporting the recovery but is data dependent and not on a preset course of cutting rates.
The Fed has reduced its benchmark rate twice in 2019 and is expected to approve a third cut late this month.
Stocks pared some of their losses as Powell spoke while short-term Treasury yields hit their lows of the day.
Time to expand ‘is now upon us’
On the balance sheet issue, overnight repurchase markets malfunctioned in several weeks ago, due in part to funding constraints caused by money getting sucked out of the system as companies made tax payments and the Treasury Department settled bond auctions. The lack of funding caused repo rates to spike as high as 10% and the Fed’s benchmark funds rate, which banks charge each other for short-term borrowing, to go above its targeted range by 5 basis points.
Since then, the Fed has been conducting temporary operations in which it is providing cash in exchange for ultra-safe assets.
Powell said the Fed is about to embark on more permanent operations to make sure the system has enough reserves and the market volatility events are controlled.
“This volatility can impede the effective implementation of monetary policy, and we are addressing it,” Powell said in prepared remarks. “Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time.”
Fed officials have been contemplating the proper level of reserves to keep in the system. The cash level that banks store at the Fed has fallen to about $1.5 trillion from a peak of $2.8 trillion in September 2014 as the Fed has ended its liquidity programs. Three rounds of quantitative easing, or asset purchases, took the balance sheet to as high as $4.5 trillion before the Fed started allowing proceeds to roll off each month.
President Donald Trump sharply criticized the balance sheet reduction, calling it “quantitative tightening” and charging that it was slowing economic growth.
Powell said the Fed is settling into an “ample reserves” regime and now sees that it is around the level banks need.
“As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves,” he said. “That time is now upon us.”
While he did not specify how the Fed will proceed he was quick to draw one line — that this program should not be confused with the three rounds of QE, which were aggressive efforts to expand the balance sheet. Instead, this will be a more organic procedure that will follow operations similar to what the Fed conducted before the financial crisis of 2008.
Both interest rate policy and the approach to the balance sheet came following a dissertation from Powell on “profound changes in the economy” and what challenges they present to current conditions.
He broke the challenges into three questions: how a gas price spike might impact the economy, whether productivity is being measured adequately and whether the labor market is tight.
A jump in gas prices probably can be absorbed and likely would have little overall impact, Powell said. Current productivity measures are likely inadequate due to technological factors, he added. And he said that jobs are likely growing more slowly than the data indicates, though still expanding quickly enough to absorb new entrants to the labor force.