Here are the factors that could lead the Fed to adopt a “Plan B” against US inflation

Amid a strong US housing market, low interest rates and alarmingly high inflation, the Federal Reserve (Fed) has continued to grow its bond portfolio, prompting calls to not just let those bonds mature over time. , but also plans to start actively selling them.

Any sales are unlikely to be included at the start of balance sheet “normalization” plans that authorities are expected to approve in the coming months, a process that will take place alongside interest rate hikes aimed at calming inflation.

But if the fight against inflation doesn’t succeed quickly enough, some Fed officials want a “Plan B” that ventures into new territory, using sales of mortgage-backed securities (MBS) to boost home mortgage rates.

This is one of the main channels the US central bank can use to reduce inflation, because it would keep home prices low and leave less room in households’ budgets for other spending.

Fed officials discussed the possibility of MBS sales at their Jan. Wednesday.

The Fed’s $2.7 trillion MBS stock acts as an anchor for interest rates in that market, preventing them from going any higher, and some officials argue that the central bank’s share of these bonds may need to shrink faster than than through natural “flow”.

This process, which leaves bonds off the balance sheet as they mature, is particularly slow and unpredictable, and can take time at a time of rising interest rates.

Bond purchases have been a controversial aspect of monetary policy, in part because of lingering doubts about the outlet strategy, with some critics arguing that selling bonds when borrowing rates are rising could cause the central bank to lose money. Bond prices fall when interest rates rise and vice versa.

The Fed avoided selling bonds when it last trimmed its balance sheet, between 2017 and 2019. Monetary policymakers want to rely primarily on the natural reduction strategy this time around, in line with principles released last month.

But some Fed officials and analysts say this passive approach may not be enough. James Bullard, chairman of the St. Louis Fed, and Esther George, chairman of the Kansas City Fed, were among those who pointed to high inflation as a concern.

The sales may also be needed to help the Fed meet its long-term goal of moving to a primarily Treasuries portfolio, Cleveland Fed President Loretta Mester said recently.

Fed officials are currently looking at the numbers on how long it might take for mortgages to come out of the portfolio on their own and no decisions have been made, Mester said.

But the Fed may want to address the possibility of asset sales early on when it starts providing guidance on its plans for balance sheet reduction, said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research.

“They’re going to want to address the issue one way or another,” she said.

Source: CNN Brasil

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