Speaker 1: Today on Benchmark, we're going to talk about the Federal Reserve,
Speaker 1: America's central bank, which is about to embark on a
Speaker 1: huge policy step that's never been tried before on this scale.
Speaker 1: Did you know that the FED owns four point five
Speaker 1: trillion dollars worth of assets, including more than two trillion
Speaker 1: of Treasury bonds and one point eight trillion dollars of
Speaker 1: mortgage securities tied to the homes of people around the country,
Speaker 1: very possibly your own or that of someone you know.
Speaker 1: The FED built up that stockpile as a way to
Speaker 1: help the U S economy during the global financial crisis
Speaker 1: and it's aftermath. Now it's about to take a major
Speaker 1: step by reducing that stockpile of assets. It might sound
Speaker 1: kind of technical, so why should you care. Well, it
Speaker 1: might make mortgage rates go up, it could make your
Speaker 1: vacation to Thailand a bit cheaper, and it could even
Speaker 1: make Donald Trump angry. I'm Scott Landman, an economics editor
Speaker 1: with Bloomberg in Washington. Joining me today is Chris Condon,
Speaker 1: who covers the FED for US in d C. Hey, Chris,
Speaker 1: how's it going very well? Scott? So, Chris, we're recording
Speaker 1: this just a short while after the FED has issued
Speaker 1: the statement from its latest meeting, what did they do
Speaker 1: and what does it mean? Well, the new thing today
Speaker 1: is really just a small tweak in the language of
Speaker 1: their post meeting statement, but it means quite a lot.
Speaker 1: Bottom line is it tells us that they're going to
Speaker 1: be reducing the size of this huge balance sheet beginning
Speaker 1: probably in October. But what do you mean by that
Speaker 1: reducing the balance sheet? What? How are they going to
Speaker 1: do this? And you know, what does it mean? Right right?
Speaker 1: I think the main word is very very carefully. They
Speaker 1: the FED ist kind of scared of its own shadow
Speaker 1: when it comes just reducing this. And by that I
Speaker 1: mean they've got this giant portfolio of bonds. In any
Speaker 1: given month, certain number of those bonds are maturing. So
Speaker 1: say they hold a treasury, the Treasury sends them the money.
Speaker 1: When the bond matures, they get your principle back, just
Speaker 1: like any other investor up until now. The FED takes
Speaker 1: that money and reinvests it in the market, buys another
Speaker 1: Treasury security, So the size of their portfolio stays exactly
Speaker 1: the same, and the pressure that they're putting on yields
Speaker 1: in that market stays exactly the same. In other words,
Speaker 1: the size of this balance sheet, these four point five
Speaker 1: trillion dollars in assets, it's like imagine a big weight
Speaker 1: on on a scale. It's kind of holding down interest
Speaker 1: rates in this country, which is the cost of mortgages,
Speaker 1: the cost to get a car loan, business moan, that
Speaker 1: sort of thing. It's just keeping that weight. And they're
Speaker 1: going to lessen that weight a little bit at a time, right,
Speaker 1: and they're gonna do that by letting some of these
Speaker 1: bonds mature and not reinvest the returned principle. And in
Speaker 1: that way, they're essentially withdrawing money from the bond market.
Speaker 1: You withdraw money from the bond market, in yields go up.
Speaker 1: That is to say, the costs to these households and
Speaker 1: businesses to borrow money starts to go up, which is
Speaker 1: just what the Fed wants at this time, because the
Speaker 1: economy is doing a little bit better, and the Fed
Speaker 1: doesn't want to keep its foot on the gas pedal
Speaker 1: so hard. It wants to ease up a little so
Speaker 1: that the economy can continue to grow without overheating. And
Speaker 1: so when this results in treasury yields going up, that
Speaker 1: will probably make the cost of mortgages, car loans and
Speaker 1: other kinds of credit go up as well. And that's
Speaker 1: actually a good sign for the economy. That means things
Speaker 1: are going well right, it does, it does as long
Speaker 1: as the stay in correct balance um that will help
Speaker 1: prevent inflation from rising too rapidly. If if these interest
Speaker 1: rates go up a little bit um now, if they
Speaker 1: go too quickly, that could pull the rug out from
Speaker 1: under this recovery. And and indeed, like I said, the
Speaker 1: Fed is scared of its own shadow over this issue.
Speaker 1: A few years ago, Ben Bernanke really caused a flutter
Speaker 1: in the bond market when he only spoke about the
Speaker 1: possibility of slowing down the pace at which the Fed
Speaker 1: was then buying bonds. They were still in the buying
Speaker 1: phase then, and he caught the market a little bit
Speaker 1: by surprise, and and there was a great reaction and
Speaker 1: yields flew up for quite for many months, called the
Speaker 1: Taper tantrum. That's our uninitiated listeners. And the Feed is
Speaker 1: was really scarred by that experience. So they have approached
Speaker 1: this entire action, which again they've never done before, with
Speaker 1: the utmost of caution. That's why you've seen this very gradual,
Speaker 1: incremental approach, so even just communicating what it is they're
Speaker 1: going to do. Now, let's turn to one other aspect
Speaker 1: of this I was talking about at the top, how
Speaker 1: this could actually make your vacation to Thailand cheaper. How
Speaker 1: do we get how do we connect the dots from
Speaker 1: this action by the FED to making a vacation in
Speaker 1: Southeast Asia a little less expensive. Well, it all has
Speaker 1: to do with how relatively attractive different investments are around
Speaker 1: the globe and the exchange rates between currencies. So any investor,
Speaker 1: a cross border investor, is going to look at, say
Speaker 1: an emerging market, and they're going to gauge the risk
Speaker 1: of investing there against the return they expect to get
Speaker 1: there compared to the return they'll get from a much
Speaker 1: safer asset like the bonds from an American company or
Speaker 1: US treasuries. Now, when the FED raises rates or the
Speaker 1: FED begins to reduce the size of its balance sheet,
Speaker 1: the returns on treasuries and the bonds connected to US
Speaker 1: companies will start to go up. So that makes them
Speaker 1: that that that squeezes that gap between the returns you
Speaker 1: can get abroad, maybe in some emerging market versus the
Speaker 1: returns you get from the safer assets and they're on
Speaker 1: the margin, makes those riskier countries a little bit less attractive,
Speaker 1: and then that makes their currencies a little less attractive
Speaker 1: as well, right, Coral, that's right right now. The the
Speaker 1: secondary impact that they this can have on an emerging
Speaker 1: market is that there can be companies in these economies
Speaker 1: that are borrowing in dollars. Now as interest rates in
Speaker 1: the US go up, the dollar, if all other things
Speaker 1: remain equal, will strengthen. Now, if a company is based
Speaker 1: in Malaysia and it's making its revenue you know, making
Speaker 1: shirts or whatever, or selling beer in the beach, and
Speaker 1: that is revenue is in the ring, get it's got
Speaker 1: to take that local currency revenue buy dollars and pay
Speaker 1: its dollar denominated loans off. That becomes more expensive as
Speaker 1: the dollar goes up and can put a lot of
Speaker 1: pressure on emerging market countries companies. So, in other words,
Speaker 1: what's bad for the emerging market countries can be good
Speaker 1: for American consumers, especially those who enjoy traveling to Southeast Asia.
Speaker 1: That is true. So when exactly is this going to
Speaker 1: start happening? When is the FED going to start doing this?
Speaker 1: And how long is is this going to go on
Speaker 1: for Well, the first part is that it looks like
Speaker 1: they're really on target to start in October. And the
Speaker 1: answer to the second part is, we really don't know yet.
Speaker 1: That's the one of the big questions they have yet
Speaker 1: to answer. They haven't told us when it comes to
Speaker 1: this quote unquote normalization of the balancy. They haven't told
Speaker 1: us what the new normal will be when they're done it.
Speaker 1: They're going to reduce it from four a half trillion
Speaker 1: to three and a half trillion or two two and
Speaker 1: a half trillion. It will make a big difference in
Speaker 1: the lorman, but they haven't actually decided that yet. But basically,
Speaker 1: this is probably going to go on for several years,
Speaker 1: barring some kind of calamity or the recession that would
Speaker 1: cause the feed to re posies for sure. But remember
Speaker 1: now that they have said they're going to begin reducing
Speaker 1: it by only ten billion dollars a month. That will
Speaker 1: slowly go up over a year's time to fifty billion
Speaker 1: a month. But even a fifty billion a month takes
Speaker 1: a long time to roll off, say a trillion dollars.
Speaker 1: In other words, they're kind of putting it on autopilot
Speaker 1: or as I like to say, it's like the showtime
Speaker 1: rotisserie oven from Ron Popel. Do you ever see that commercial? Chris?
Speaker 1: I think I have said it and forget it. That's
Speaker 1: what the FED is doing to its balance sheet policy
Speaker 1: here if it goes well. Right, we talked about how
Speaker 1: cautious they are when it comes to reacting to changing
Speaker 1: economic conditions. They still want their the FED Funds rate,
Speaker 1: the policy rate set by the FED, to be the
Speaker 1: main tool for reacting. So if if inflation starts to
Speaker 1: go up and they decide they have to tighten, they'll
Speaker 1: raise the FED funds rate in reaction to that. They're
Speaker 1: not going to suddenly speed up the boundary. They want
Speaker 1: this balance sheet to go along a set course, get
Speaker 1: it running without disrupting the market, fingers crossed, and then
Speaker 1: just let it quietly run in the background. Right, So
Speaker 1: let's talk about the third thing I mentioned at the top,
Speaker 1: which is President Donald Trump. Why might he not be
Speaker 1: too happy about this or even get angry about it?
Speaker 1: In President Trump's own words, I'm a low interest rate guy. Honestly,
Speaker 1: it's probably not fair to pick on him about this,
Speaker 1: because every president, once they're in office, is a low
Speaker 1: interest rate guy. Presidents are thinking about if they're in
Speaker 1: their a term of thinking about their reelection, what helps
Speaker 1: with their reelection where the economy is now or next
Speaker 1: year right in the short term. The Fed thinks on
Speaker 1: a much longer term basis, and they may increased interest
Speaker 1: rates to head off trouble down the road. That won't
Speaker 1: police presidents, because they want to keep the economy juiced
Speaker 1: in running is as high as they can get it
Speaker 1: going before their their election. So and and let's not
Speaker 1: forget that rolling assets off the balance sheet. Reducing this
Speaker 1: balance sheet has the same ultimate effect. Maybe not is
Speaker 1: is large an impact, but it's in the same direction
Speaker 1: as raising interest rates. It raises the costs of borrowing
Speaker 1: for households and companies. That slows down the economy on
Speaker 1: the margin. And so you might find at some point
Speaker 1: the president is critical of this. It is, to be honest,
Speaker 1: more likely that he's going to be critical of at
Speaker 1: an interest rate increase, because that is much more consequential
Speaker 1: in one swoop in terms of the credit market than
Speaker 1: the balance sheet. Although there is kind of a sweep
Speaker 1: of strategy here, you have to you have to give
Speaker 1: some credit to the current FED chair Janet yell, And
Speaker 1: she's actually implementing a policy that is going to run
Speaker 1: for several years. And at the same time, her term
Speaker 1: is up in just a few months, and Trump is
Speaker 1: contemplating whether to reappoint her or replace her with someone else,
Speaker 1: like his economic advisor Gary Khne. So she's actually doing
Speaker 1: something that is going to take away potentially some of
Speaker 1: the power of the next FED chair if it turns
Speaker 1: out to be some someone other than her. Right, that's right,
Speaker 1: it's I don't think it's ever really possible to tie
Speaker 1: the next FED chairs hands completely, but it does make
Speaker 1: it more difficult if if they get off the blocks
Speaker 1: smoothly in reducing this balance sheet, and the process begins
Speaker 1: and it's going along and makes it very difficult for
Speaker 1: the next FED chair to come in and say, oh no, no,
Speaker 1: we've got to change this in one direction or the other,
Speaker 1: say to slow down or speed it up. It's something
Speaker 1: that's working, and things that are working or in monetary
Speaker 1: policy are best left to themselves. One last question, can't
Speaker 1: we come up with some other name for this than
Speaker 1: balance sheet normalization? I mean, we had some other good
Speaker 1: shorthand names for other FED programs, like Operation Twist or
Speaker 1: QUEI that we're kind of pretty easy to remember, easy
Speaker 1: to communicate with the general public. Why can't they just
Speaker 1: come up with something good here? Well, you mentioned qui
Speaker 1: if bond buying was, and that comes from the word
Speaker 1: the term quantitative easing. Um, So if that's a mouthful
Speaker 1: quant state of easing is que we could call this
Speaker 1: quantitative tightening or QT, because we know the FED wants
Speaker 1: to do it on the QT. Ha, that's a good one, Chris.
Speaker 1: That counts for funny in FED world. Well, let's see
Speaker 1: if that can stick in some of our stories. Chris Condon,
Speaker 1: it was great to have you on. Thanks for joining
Speaker 1: us today to talk about the FED. My Pleasure Benchmark
Speaker 1: will be back next week and until then, you can
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Speaker 1: You can follow me or tweet at me at at
Speaker 1: Scott Landman and Chris you are at Chris JA Condon.
Speaker 1: Benchmark is produced by Sarah Patterson and The head of
Speaker 1: Bloomberg Podcasts is Alec McCabe. Thanks for listening, See you
Speaker 1: next time. Four