Federal Reserve Bank of Cleveland President Beth Hammack reckons the U.S. central bank can keep steadily shrinking its balance sheet through a period of uncertain government finances, while noting she is disinclined to support an interest rate hike even if inflation pressures do not retreat quickly enough.
Hammack said her "baseline preference" is that the Fed presses forward with the balance sheet drawdown commonly referred to as quantitative tightening, or QT, while the government sorts out its spending plans and adjusts the debt ceiling to facilitate its borrowing needs.
Once that is resolved, the Fed can use temporary bond repurchases, or repos, if needed, "to put more (liquidity) back in the system until you figure out" the market's needs, Hammack said in an interview with Reuters on Thursday.
Once government funding issues are squared up, "while there may be in aggregate enough reserves, if the distribution of it is not as efficient across the system, you need some mechanism for getting it to all the right places," she said. Temporary liquidity additions can accomplish that, she noted.
Hammack was addressing the QT outlook after minutes released last week from the Federal Open Market Committee's late-January meeting showed an unknown number of officials weighed slowing or pausing the QT process.
Policymakers are considering the shift because getting a read on market liquidity during this period will be difficult, the minutes said. They do not want to withdraw too much liquidity lest the central bank rattles the money market and loses firm control over the federal funds rate, its main tool to influence the economy's direction, the minutes said.
Since 2022, the Fed has not been replacing some of its expired Treasury and mortgage bonds, allowing its portfolio to fall to $6.8 trillion from a peak of $9 trillion. The Fed has been unclear how far this process can play out and is letting market data inform how much liquidity it can withdraw before it halts QT.
Ahead of the Fed's January meeting, market participants had been eyeing an early summer stopping point.
With repos, Hammack said the Fed can manage the withdrawal of market liquidity the Treasury cash management will create as it manages its finances after a debt ceiling resolution. When it comes to QT, "I do think it can go a bit longer," Hammack said.
Longer run, the official said she does not expect the Fed to sell mortgage bonds, which have been slow to expire off the Fed's holdings despite its official goal of getting toward mostly Treasury holdings.
FUNDS RATE STEADY STATE
"I believe that monetary policy has the luxury of being patient as we assess the path forward," even with a healthy job market and uneven cooling in inflation pressures, Hammack said in a speech prior to the interview. "This will likely mean holding the federal funds rate steady for some time."
In the interview, she said she does not expect a rate hike if inflation pressures remain above the Fed's 2% target, but the odds of such a move are not zero.
Hammack also said recent data suggesting the public may be bracing for higher inflation is on her radar but so far, when it comes to expectations of future price pressures, "I think (expectations) are still anchored."
Hammack said it is too soon to say what the Trump administration's regime of trade tariffs means for inflation, and that everything depends on what is done and how other nations respond.
