Janet Yellen

Federal Reserve officials are pretty proud of their plan to reduce their balance sheet following a sharp expansion during and after the Great Recession.

Policymakers are especially excited they were able to announce the plan’s contours without having markets totally freak out, like they did in 2013 when then-Chairman Ben Bernanke gave the first hint that the Fed would be ceasing its bond-buying program. Bond yields spiked sharply higher at the time in an event that became known as the taper-tantrum.

Seeking to avoid a repeat of that debacle, officials have gone out of their way to give traders clarity, well ahead of time, into their expectations for balance sheet reduction. There’s just one problem: the central bank’s outline is more a wish list than a blueprint, and investors are starting to catch on.

In particular, two very big questions remain unresolved: First, when will the Fed begin the process of unwinding the balance sheet by halting its practice of reinvesting the proceeds from maturing bonds back into the Treasury or mortgage-backed securities markets? And second, what is policymakers’ target for the eventual end-size of the balance sheet?

The timing issue is more relevant to short-term traders. “One crucial detail the Fed did not provide: when it will commence that process of balance sheet normalization,” wrote Richard Clarida, a managing director at PIMCO, in a research note.

But the size of the balance sheet, at least according to the Fed’s own monetary theory, is what really matters in gauging the amount of overall stimulus being provided to the economy.

Economists at UBS say they were “disappointed not to see some explanation for the convoluted system of ‘caps’ the Fed has put in place to run off its balance sheet.”

“As it stands, the caps will limit the balance sheet runoff only for the …read more

Source:: Business Insider

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