WEBVTT - Why Everyone Needs to Care About the Fed's Shrinking Balance Sheet

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<v Speaker 1>Today on Benchmark, we're going to talk about the Federal Reserve,

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<v Speaker 1>America's central bank, which is about to embark on a

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<v Speaker 1>huge policy step that's never been tried before on this scale.

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<v Speaker 1>Did you know that the FED owns four point five

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<v Speaker 1>trillion dollars worth of assets, including more than two trillion

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<v Speaker 1>of Treasury bonds and one point eight trillion dollars of

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<v Speaker 1>mortgage securities tied to the homes of people around the country,

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<v Speaker 1>very possibly your own or that of someone you know.

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<v Speaker 1>The FED built up that stockpile as a way to

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<v Speaker 1>help the U S economy during the global financial crisis

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<v Speaker 1>and it's aftermath. Now it's about to take a major

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<v Speaker 1>step by reducing that stockpile of assets. It might sound

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<v Speaker 1>kind of technical, so why should you care. Well, it

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<v Speaker 1>might make mortgage rates go up, it could make your

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<v Speaker 1>vacation to Thailand a bit cheaper, and it could even

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<v Speaker 1>make Donald Trump angry. I'm Scott Landman, an economics editor

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<v Speaker 1>with Bloomberg in Washington. Joining me today is Chris Condon,

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<v Speaker 1>who covers the FED for US in d C. Hey, Chris,

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<v Speaker 1>how's it going very well? Scott? So, Chris, we're recording

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<v Speaker 1>this just a short while after the FED has issued

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<v Speaker 1>the statement from its latest meeting, what did they do

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<v Speaker 1>and what does it mean? Well, the new thing today

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<v Speaker 1>is really just a small tweak in the language of

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<v Speaker 1>their post meeting statement, but it means quite a lot.

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<v Speaker 1>Bottom line is it tells us that they're going to

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<v Speaker 1>be reducing the size of this huge balance sheet beginning

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<v Speaker 1>probably in October. But what do you mean by that

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<v Speaker 1>reducing the balance sheet? What? How are they going to

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<v Speaker 1>do this? And you know, what does it mean? Right right?

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<v Speaker 1>I think the main word is very very carefully. They

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<v Speaker 1>the FED ist kind of scared of its own shadow

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<v Speaker 1>when it comes just reducing this. And by that I

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<v Speaker 1>mean they've got this giant portfolio of bonds. In any

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<v Speaker 1>given month, certain number of those bonds are maturing. So

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<v Speaker 1>say they hold a treasury, the Treasury sends them the money.

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<v Speaker 1>When the bond matures, they get your principle back, just

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<v Speaker 1>like any other investor up until now. The FED takes

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<v Speaker 1>that money and reinvests it in the market, buys another

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<v Speaker 1>Treasury security, So the size of their portfolio stays exactly

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<v Speaker 1>the same, and the pressure that they're putting on yields

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<v Speaker 1>in that market stays exactly the same. In other words,

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<v Speaker 1>the size of this balance sheet, these four point five

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<v Speaker 1>trillion dollars in assets, it's like imagine a big weight

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<v Speaker 1>on on a scale. It's kind of holding down interest

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<v Speaker 1>rates in this country, which is the cost of mortgages,

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<v Speaker 1>the cost to get a car loan, business moan, that

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<v Speaker 1>sort of thing. It's just keeping that weight. And they're

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<v Speaker 1>going to lessen that weight a little bit at a time, right,

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<v Speaker 1>and they're gonna do that by letting some of these

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<v Speaker 1>bonds mature and not reinvest the returned principle. And in

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<v Speaker 1>that way, they're essentially withdrawing money from the bond market.

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<v Speaker 1>You withdraw money from the bond market, in yields go up.

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<v Speaker 1>That is to say, the costs to these households and

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<v Speaker 1>businesses to borrow money starts to go up, which is

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<v Speaker 1>just what the Fed wants at this time, because the

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<v Speaker 1>economy is doing a little bit better, and the Fed

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<v Speaker 1>doesn't want to keep its foot on the gas pedal

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<v Speaker 1>so hard. It wants to ease up a little so

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<v Speaker 1>that the economy can continue to grow without overheating. And

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<v Speaker 1>so when this results in treasury yields going up, that

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<v Speaker 1>will probably make the cost of mortgages, car loans and

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<v Speaker 1>other kinds of credit go up as well. And that's

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<v Speaker 1>actually a good sign for the economy. That means things

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<v Speaker 1>are going well right, it does, it does as long

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<v Speaker 1>as the stay in correct balance um that will help

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<v Speaker 1>prevent inflation from rising too rapidly. If if these interest

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<v Speaker 1>rates go up a little bit um now, if they

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<v Speaker 1>go too quickly, that could pull the rug out from

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<v Speaker 1>under this recovery. And and indeed, like I said, the

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<v Speaker 1>Fed is scared of its own shadow over this issue.

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<v Speaker 1>A few years ago, Ben Bernanke really caused a flutter

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<v Speaker 1>in the bond market when he only spoke about the

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<v Speaker 1>possibility of slowing down the pace at which the Fed

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<v Speaker 1>was then buying bonds. They were still in the buying

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<v Speaker 1>phase then, and he caught the market a little bit

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<v Speaker 1>by surprise, and and there was a great reaction and

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<v Speaker 1>yields flew up for quite for many months, called the

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<v Speaker 1>Taper tantrum. That's our uninitiated listeners. And the Feed is

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<v Speaker 1>was really scarred by that experience. So they have approached

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<v Speaker 1>this entire action, which again they've never done before, with

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<v Speaker 1>the utmost of caution. That's why you've seen this very gradual,

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<v Speaker 1>incremental approach, so even just communicating what it is they're

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<v Speaker 1>going to do. Now, let's turn to one other aspect

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<v Speaker 1>of this I was talking about at the top, how

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<v Speaker 1>this could actually make your vacation to Thailand cheaper. How

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<v Speaker 1>do we get how do we connect the dots from

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<v Speaker 1>this action by the FED to making a vacation in

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<v Speaker 1>Southeast Asia a little less expensive. Well, it all has

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<v Speaker 1>to do with how relatively attractive different investments are around

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<v Speaker 1>the globe and the exchange rates between currencies. So any investor,

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<v Speaker 1>a cross border investor, is going to look at, say

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<v Speaker 1>an emerging market, and they're going to gauge the risk

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<v Speaker 1>of investing there against the return they expect to get

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<v Speaker 1>there compared to the return they'll get from a much

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<v Speaker 1>safer asset like the bonds from an American company or

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<v Speaker 1>US treasuries. Now, when the FED raises rates or the

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<v Speaker 1>FED begins to reduce the size of its balance sheet,

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<v Speaker 1>the returns on treasuries and the bonds connected to US

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<v Speaker 1>companies will start to go up. So that makes them

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<v Speaker 1>that that that squeezes that gap between the returns you

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<v Speaker 1>can get abroad, maybe in some emerging market versus the

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<v Speaker 1>returns you get from the safer assets and they're on

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<v Speaker 1>the margin, makes those riskier countries a little bit less attractive,

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<v Speaker 1>and then that makes their currencies a little less attractive

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<v Speaker 1>as well, right, Coral, that's right right now. The the

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<v Speaker 1>secondary impact that they this can have on an emerging

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<v Speaker 1>market is that there can be companies in these economies

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<v Speaker 1>that are borrowing in dollars. Now as interest rates in

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<v Speaker 1>the US go up, the dollar, if all other things

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<v Speaker 1>remain equal, will strengthen. Now, if a company is based

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<v Speaker 1>in Malaysia and it's making its revenue you know, making

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<v Speaker 1>shirts or whatever, or selling beer in the beach, and

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<v Speaker 1>that is revenue is in the ring, get it's got

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<v Speaker 1>to take that local currency revenue buy dollars and pay

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<v Speaker 1>its dollar denominated loans off. That becomes more expensive as

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<v Speaker 1>the dollar goes up and can put a lot of

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<v Speaker 1>pressure on emerging market countries companies. So, in other words,

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<v Speaker 1>what's bad for the emerging market countries can be good

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<v Speaker 1>for American consumers, especially those who enjoy traveling to Southeast Asia.

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<v Speaker 1>That is true. So when exactly is this going to

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<v Speaker 1>start happening? When is the FED going to start doing this?

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<v Speaker 1>And how long is is this going to go on

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<v Speaker 1>for Well, the first part is that it looks like

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<v Speaker 1>they're really on target to start in October. And the

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<v Speaker 1>answer to the second part is, we really don't know yet.

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<v Speaker 1>That's the one of the big questions they have yet

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<v Speaker 1>to answer. They haven't told us when it comes to

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<v Speaker 1>this quote unquote normalization of the balancy. They haven't told

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<v Speaker 1>us what the new normal will be when they're done it.

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<v Speaker 1>They're going to reduce it from four a half trillion

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<v Speaker 1>to three and a half trillion or two two and

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<v Speaker 1>a half trillion. It will make a big difference in

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<v Speaker 1>the lorman, but they haven't actually decided that yet. But basically,

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<v Speaker 1>this is probably going to go on for several years,

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<v Speaker 1>barring some kind of calamity or the recession that would

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<v Speaker 1>cause the feed to re posies for sure. But remember

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<v Speaker 1>now that they have said they're going to begin reducing

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<v Speaker 1>it by only ten billion dollars a month. That will

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<v Speaker 1>slowly go up over a year's time to fifty billion

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<v Speaker 1>a month. But even a fifty billion a month takes

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<v Speaker 1>a long time to roll off, say a trillion dollars.

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<v Speaker 1>In other words, they're kind of putting it on autopilot

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<v Speaker 1>or as I like to say, it's like the showtime

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<v Speaker 1>rotisserie oven from Ron Popel. Do you ever see that commercial? Chris?

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<v Speaker 1>I think I have said it and forget it. That's

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<v Speaker 1>what the FED is doing to its balance sheet policy

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<v Speaker 1>here if it goes well. Right, we talked about how

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<v Speaker 1>cautious they are when it comes to reacting to changing

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<v Speaker 1>economic conditions. They still want their the FED Funds rate,

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<v Speaker 1>the policy rate set by the FED, to be the

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<v Speaker 1>main tool for reacting. So if if inflation starts to

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<v Speaker 1>go up and they decide they have to tighten, they'll

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<v Speaker 1>raise the FED funds rate in reaction to that. They're

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<v Speaker 1>not going to suddenly speed up the boundary. They want

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<v Speaker 1>this balance sheet to go along a set course, get

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<v Speaker 1>it running without disrupting the market, fingers crossed, and then

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<v Speaker 1>just let it quietly run in the background. Right, So

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<v Speaker 1>let's talk about the third thing I mentioned at the top,

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<v Speaker 1>which is President Donald Trump. Why might he not be

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<v Speaker 1>too happy about this or even get angry about it?

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<v Speaker 1>In President Trump's own words, I'm a low interest rate guy. Honestly,

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<v Speaker 1>it's probably not fair to pick on him about this,

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<v Speaker 1>because every president, once they're in office, is a low

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<v Speaker 1>interest rate guy. Presidents are thinking about if they're in

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<v Speaker 1>their a term of thinking about their reelection, what helps

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<v Speaker 1>with their reelection where the economy is now or next

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<v Speaker 1>year right in the short term. The Fed thinks on

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<v Speaker 1>a much longer term basis, and they may increased interest

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<v Speaker 1>rates to head off trouble down the road. That won't

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<v Speaker 1>police presidents, because they want to keep the economy juiced

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<v Speaker 1>in running is as high as they can get it

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<v Speaker 1>going before their their election. So and and let's not

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<v Speaker 1>forget that rolling assets off the balance sheet. Reducing this

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<v Speaker 1>balance sheet has the same ultimate effect. Maybe not is

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<v Speaker 1>is large an impact, but it's in the same direction

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<v Speaker 1>as raising interest rates. It raises the costs of borrowing

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<v Speaker 1>for households and companies. That slows down the economy on

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<v Speaker 1>the margin. And so you might find at some point

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<v Speaker 1>the president is critical of this. It is, to be honest,

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<v Speaker 1>more likely that he's going to be critical of at

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<v Speaker 1>an interest rate increase, because that is much more consequential

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<v Speaker 1>in one swoop in terms of the credit market than

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<v Speaker 1>the balance sheet. Although there is kind of a sweep

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<v Speaker 1>of strategy here, you have to you have to give

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<v Speaker 1>some credit to the current FED chair Janet yell, And

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<v Speaker 1>she's actually implementing a policy that is going to run

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<v Speaker 1>for several years. And at the same time, her term

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<v Speaker 1>is up in just a few months, and Trump is

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<v Speaker 1>contemplating whether to reappoint her or replace her with someone else,

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<v Speaker 1>like his economic advisor Gary Khne. So she's actually doing

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<v Speaker 1>something that is going to take away potentially some of

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<v Speaker 1>the power of the next FED chair if it turns

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<v Speaker 1>out to be some someone other than her. Right, that's right,

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<v Speaker 1>it's I don't think it's ever really possible to tie

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<v Speaker 1>the next FED chairs hands completely, but it does make

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<v Speaker 1>it more difficult if if they get off the blocks

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<v Speaker 1>smoothly in reducing this balance sheet, and the process begins

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<v Speaker 1>and it's going along and makes it very difficult for

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<v Speaker 1>the next FED chair to come in and say, oh no, no,

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<v Speaker 1>we've got to change this in one direction or the other,

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<v Speaker 1>say to slow down or speed it up. It's something

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<v Speaker 1>that's working, and things that are working or in monetary

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<v Speaker 1>policy are best left to themselves. One last question, can't

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<v Speaker 1>we come up with some other name for this than

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<v Speaker 1>balance sheet normalization? I mean, we had some other good

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<v Speaker 1>shorthand names for other FED programs, like Operation Twist or

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<v Speaker 1>QUEI that we're kind of pretty easy to remember, easy

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<v Speaker 1>to communicate with the general public. Why can't they just

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<v Speaker 1>come up with something good here? Well, you mentioned qui

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<v Speaker 1>if bond buying was, and that comes from the word

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<v Speaker 1>the term quantitative easing. Um, So if that's a mouthful

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<v Speaker 1>quant state of easing is que we could call this

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<v Speaker 1>quantitative tightening or QT, because we know the FED wants

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<v Speaker 1>to do it on the QT. Ha, that's a good one, Chris.

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<v Speaker 1>That counts for funny in FED world. Well, let's see

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<v Speaker 1>if that can stick in some of our stories. Chris Condon,

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<v Speaker 1>it was great to have you on. Thanks for joining

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<v Speaker 1>us today to talk about the FED. My Pleasure Benchmark

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<v Speaker 1>will be back next week and until then, you can

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<v Speaker 1>find us on the Bloomberg terminal, Bloomberg dot com or

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<v Speaker 1>Bloomberg app, as well as on Apple Podcasts, pocket casts,

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<v Speaker 1>and Stitcher. While you're there, take a minute to rate

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<v Speaker 1>and review the show so more listeners can find us

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<v Speaker 1>and let us know what you thought of the show.

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<v Speaker 1>You can follow me or tweet at me at at

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<v Speaker 1>Scott Landman and Chris you are at Chris JA Condon.

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<v Speaker 1>Benchmark is produced by Sarah Patterson and The head of

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<v Speaker 1>Bloomberg Podcasts is Alec McCabe. Thanks for listening, See you

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<v Speaker 1>next time. Four