Fed Plans to Drastically Reduce its Balance Sheet Starting in May

Officials at the Federal Reserve agreed at their March meeting to begin selling off assets from the central bank balance sheet beginning as early as May. Minutes from the meeting indicated that the Fed plans to reduce its balance sheet by up to $95 billion per month while also continuing to raise interest rates. Fed officials strongly indicated that 50-basis point, or half-percentage point, interest rate increases are coming soon. The Fed will take such hawkish actions in an effort to break the back of inflation, much like Fed Chair Paul Volcker did in the 1980s, the last time inflation numbers in the United States were this high.

Markets have been spooked by such fierce Fed rhetoric. The aggressive tone and diction of Fed chair Jerome Powell and other Fed officials represents a seismic shift from the incredibly easy monetary policy from which markets have greatly benefited in recent years. Over the course of the past two years, interest rates have mostly been at zero (they only recently rose to a quarter of a percent, or 25 basis points), and the Fed has substantially expanded its balance sheet, as it has purchased bonds, mortgage-backed securities, and many other assets to help prop up markets in the wake of the COVID-19 pandemic. Now, because inflation has become so pernicious, quantitative tightening in the form of rate hikes and balance sheet reduction has become a necessity, according to Fed officials.

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Some experts claim that the 25-basis point hike in March would have been a 50-basis point hike had it not been for the uncertainty around the war in Ukraine. Many of those same experts are warning market participants that a 50-basis point hike is all but certain come May. Quincy Krosby, Chief Equity Strategist at LPL Financial, warns that if you think the Fed will continue to be dovish in efforts to keep markets participants happy, “you’re wrong,” according to CNBC.

Powell and Fed officials seem unperturbed as stocks have continued to fall in tandem with the release of Fed meeting minutes. Krosby claims that the Fed has offered fair warning to the market; the Fed has made it clear that its current mandate is to fight inflation at all costs – much like Volcker did in the 1980s by raising rates, right before plunging the country into a recession.