Fed Prepares to Maintain Record Balance Sheet for Years

Benefits and risks of turning the Fed into one of the biggest players in global money markets.

Federal Reserve officials, concerned that selling bonds from their $4.3 trillion portfolio could crush the U.S. recovery, are preparing to keep their balance sheet close to record levels for years.

Central bankers are stepping back from a three-year-old strategy for an exit from the unprecedented easing they deployed to battle the worst recession since the Great Depression. Minutes of their last meeting in April made no mention of asset sales.

“Ambitious use of a central bank’s balance sheet to channel credit to particular economic sectors or entities threatens to entangle the central bank in distributional politics and place the bank’s independence at risk,” Richmond Fed president Jeffrey Lacker, one of the biggest internal critics of the policy, said in a May 13 speech.

The Fed’s purchases created $2.54 trillion of bank reserves in excess of what lenders are required to hold against deposits. The central bank needs to tie up or extinguish that money to raise the short-term interest rate above its current range of zero to 0.25 percent.

The reason, according to Cunningham: Officials want to avoid a repeat of the “violent reaction” when Bernanke said last June that the Fed would begin to taper its asset purchases soon. Ten-year Treasury yields jumped 0.81 percentage points in less than three months after those comments, and 30-year mortgage rates increased by 0.66 point.

Housing markets sputtered. After boosting the economy for 12 straight quarters, residential investment subtracted 0.26 percentage point from growth in the fourth quarter of 2013 and 0.18 point in the first period of this year, when the economy as a whole contracted.

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