Fed Tiptoes Toward Dialing Back Key Channel of Monetary Tightening

livemint.com:

Though the Federal Reserve stopped raising interest rates last summer, it is quietly tightening monetary policy through another channel: shrinking its $7.7 trillion holdings of bonds and other assets by around $80 billion a month. Now that, too, may change. Fed officials are to start deliberations on slowing, though not ending, that so-called quantitative tightening as soon as their policy meeting this month.

It could have important implications for financial markets. The Fed can shrink its holdings by selling bonds or, as it has preferred, allowing bonds to mature and “run off" its balance sheet without buying new ones. Runoff increases the supply of bonds that investors must absorb, putting upward pressure on long-term interest rates.

Slowing runoff reduces that upward pressure. But whereas the Fed expects to cut short-term interest rates this year because inflation has fallen, its rationale for tapering bond runoff is different: to prevent disruption to an obscure yet critical corner of the financial markets. Five years ago, balance-sheet runoff sparked upheaval in those markets, forcing a messy U-turn.

Officials are determined not to do that again. Several officials at the Fed’s policy meeting last month suggested beginning formal conversations soon, so as to communicate their plans to the public well before any changes take effect, according to minutes of the meeting. Officials have indicated that changes aren’t imminent and that they are focusing on slowing—not ending—the program.

The Fed began building up its huge stash of bonds during the 2008 financial crisis. At the time, it had already cut the short-term interest rate to near zero. Buying bonds, or “quantitative easing," was intended to deliver further