(Bloomberg) — Federal Reserve Bank of Dallas President Lorie Logan said the U.S. central bank may need to slow the pace at which it shrinks its asset portfolio given tighter liquidity in financial markets.
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While there is still more than enough liquidity in the financial system, individual banks could face shortages, she said. At an event in San Antonio on Saturday, Logan said it was now “appropriate” to begin discussing the parameters of a Fed decision to slow the pace of its balance sheet depletion.
“In my opinion, we should slow the pace of outflow as ON-RRP balances approach low levels,” Logan said, referring to the Fed's reverse repurchase facility overnight, where counterparties such as money market mutual funds have excess Can park cash.
“A slower balance sheet normalization can actually help achieve a more efficient balance sheet in the long run by smoothing the redistribution and reducing the likelihood that we will have to exit early,” she added.
Logan's early call to consider slowing balance sheet deleveraging – in other words, rolling back another form of monetary tightening – has authority given her previous role as a top official in the New York Fed's markets department.
According to minutes of that meeting released on Wednesday, policymakers discussed a possible slowdown in balance sheet deleveraging at the Fed meeting on December 12 and 13. Several policymakers indicated that they should begin discussing the technical factors that would influence the decision, and Logan's comments on Saturday about the rapid decline in overnight repo facilities provide a starting point.
The Fed has let some maturing assets off its balance sheet rather than reinvest in more securities as it normalizes policy away from pandemic-era stimulus. His asset portfolio has shrunk from nearly $9 trillion in 2022 to $7.68 trillion.
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The head of the Dallas Fed, who is not voting on monetary policy decisions this year, also said policymakers may need to raise interest rates further if a turnaround in consumer demand causes inflation to rise again.
“If we do not keep financial conditions sufficiently tight, there is a risk that inflation will rise again and erase the progress we have made,” Logan said. “Given the easing of financing conditions in recent months, we should not take the possibility of a further rate hike off the table just yet.”
Despite her warnings on interest rates, Logan's comments on the balance sheet are in line with a broader move by the central bank to normalize monetary policy in 2024, after raising interest rates since early 2022 to combat high and stubborn inflation.
Logan, speaking on a panel about monetary policy implementation and markets at the American Economic Association's annual meeting, said the impact of the Fed's rate hikes so far has already had a ripple effect on the economy.
Tighter financial conditions played a key role in rebalancing demand and supply and keeping inflation expectations at stable levels, Logan said. A turnaround in recent months – the 10-year Treasury yield is at 4.05%, down from nearly 5% in October, and stocks have recovered since then – could boost overall demand, she said.
“In recent months, long-term yields have given up most of the tightening we saw over the summer,” Logan said. “We cannot expect to maintain price stability if we do not maintain sufficiently restrictive financial conditions.”
Fed officials raised interest rates to a range of 5.25% to 5.5% in the 17 months through July, a 22-year high, but left policy unchanged since then as progress was made in cooling inflation. None of the 19 policymakers see a rise in interest rates in economic forecasts released after their December meeting, which markets saw as a turning point in policy and subsequently rallied.
(Updates with background information begin in sixth paragraph.)
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