Boston Fed President Eric Rosengren defended against claims that Fed’s balance sheet run-off caused financial markets turbulence during last Q4. He said, “concerns about the international economy, potential trade disputes, and a U.S. government shutdown are much more plausible explanations”. Rosengren pointed out that the balance reduction is “still quite gradual”. Meanwhile, equity markets experienced a “substantial recovery” in the first two months this year, even though the runoff was “slightly faster” than in Q4.
Also, as Fed purchased long-term securities, it encouraged investors to “big up” the price and lower rates on other higher-duration securities. Thus, there was spillover to a wide array of other asset prices. With “quantitative tightening”, Treasury yields and term premia would move higher. But back in December, treasury rate indeed feel and term premium remained quit low. That shouldn’t be the reaction to the balance sheet runoff.
Looking forward, Rosengren said it’s “unrealistic to expect the Federal Reserve’s balance sheet to return to the size it was before the financial crisis”. Meanwhile, in a hypothetical next recession, central banks will have little room to reduce short-term rates. Thus, there will be increased need to utilize the balance sheet as stimulative tool of monetary policy.
