Federal Reserve Signals Pause in Policy Tightening Citing Global Economic Risks

The US Federal Reserve System plans to halt interest rates hikes and reductions of its asset portfolio this year, in order to prevent possible negative effects to economic growth amid risks from overseas.

Kristian Rouz — The most recent policy document from the US central banking system suggests the Fed is planning to halt increases in interest rates and balance sheet reductions, effectively suspending its tightening cycle — known as 'quantitative tapering' (QT).

According to minutes from the Fed policy board's January meeting, policymakers selected a 'do not harm' approach above the intent to normalise monetary conditions in the US.

The Fed's base borrowing costs currently stand within the range of 2.25-2.5 percent, meaning US monetary policy remain accommodative, or supportive of economic growth. Most economists agree that the 'neutral' interest rate amid current economic conditions would be closer to 3 percent.

However, some policymakers, according to the Fed minutes, didn't rule out that the central bank system could bring interest rates closer to 'neutral' — which neither supports nor holds back GDP expansion — later this year, if macroeconomic risks subside.

"Several other participants indicated that, if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year", the Fed said in the minutes.

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Meanwhile, the US central bank's balance sheet stands at roughly $4 trln — down from its record high of some $4.4 trln during the period of 2014-2017. A larger balance sheet — or the Fed's holdings of bonds and other financial assets — allows for easier policy adjustments during economic crises, whereas a bloated balance sheet diminishes the efficiency of central bank policy.

Over the past year, the Fed has successfully reduced its asset holdings by some $400 bln, in line with its broader normalisation of monetary conditions (which also included four interest rate hikes last year).

However, policymakers believe, now is the time to wait and see whether tighter monetary conditions in the US start weighing on economic growth this year.

"Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve's asset holdings later this year", the minutes said.

Economists believe the Fed has been concerned with the possible negative effects to US economic expansion posed by trade tensions with China, an elongated government shutdown in December-January, as well as the on-going cooling of the global economy.

"Bottom line, while the Fed, I believe clearly had room for the current pause because of the economic slowdown going on overseas, it should also be clear to everyone that they are mostly beholden to asset prices, both the stock market and credit spreads with that driving policy", Peter Boockvar of Bleakley Advisory Group said.

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However, central bankers also suggested if the on-going deregulation and capital expenditures (corporate investment) contribute to further increase in employment and inflation, policy tightening could continue.