Sunday, June 25, 2017

QE-Unwind may start in September

Our intro to May 16's "Gavyn Davies: 'The consequences of shrinking the Fed’s balance sheet'":
This has the potential to be the most important econ/finance/market story of the second half of this year.... 
A no-brainer, and I'm just the person to say it.
From Wolf Street:

Rising Wages Scare the Fed: “We Need to Get on with This”  
QE-Unwind may start in September.
“We need to get on with this,” said Philadelphia Fed President Patrick Harker, a voting member of the policy-setting Federal Open Market Committee. He was talking about the Fed’s plan, detailed at the last meeting, to unwind QE. A possible moment to begin the process, he said, is the meeting in September.

His reasons: Complaints by his business contacts about rising wages.

Rising wages – regardless of what Fed Chair Yellen says publicly to soothe the nerves of the many underpaid workers – set off alarm bells at the Fed and push it into action. Not that all wages are rising. But average wages are rising faster than inflation, and in a number of sectors there are significant wage pressures. Businesses gripe. The Fed listens.

Harker told the Financial Times there was “very little slack” left in the labor market. “There is a rate [of unemployment] below which you are going to start to see a significant acceleration of wages.”
“You look at this labor market and you do have to question when we are going to start to see some increases in inflation,” he said. “We know from history that when that happens it happens pretty quickly.”

Hence, unwinding QE is on the table.

Bernanke explained in 2010 that QE was designed to create the “wealth effect,” where asset holders get wealthier (Part A) as asset prices are inflating, and thus they’d spend more and crank up the economy (Part B). Part A worked. Asset bubbles are now everywhere. Part B failed.

Now the question is when to reverse this wealth effect. There has apparently been unanimous agreement at the last meeting about the nuts and bolts of this plan. Initially, the Fed’s $4.5 trillion balance sheet will shed about $10 billion a month, which will rise over the next 12 months to $50 billion a month, and then continue at that level. This will amount to trimming the balance sheet by $600 billion a year.

The unwind could be launched “this year,” the FOMC statement said. Based on the FOMC meeting schedule, I mentioned at the time that this might happen “as soon as September.” Now Harker said it out loud.

The logic behind it? There will be four more FOMC meetings this year:
  • July 25-26 (no presser)
  • September 19-20 followed by Yellen’s press conference.
  • October/November 31-1 (no presser)
  • December 12-13 followed by Yellen’s press conference.

See also:
It Seems the Wealth Effect Isn't As Efficient as It Used To Be
June 22
Great Graphic: Selected GDP Performance and Policy Since 2008
May 25
"Fed Trial Balloon: JPM Warns Fed May Start Shrinking Balance Sheet In September"
May 25
Shrinking The Federal Reserve's Balance Sheet
So, reducing the Fed’s balance sheet at the same time they are raising interest rates.
And since this is uncharted territory we aren't quite sure how, exactly, the shrinkage will affect...stuff.
Should be interesting.