Fed may start normalising balance sheet later this year, Dudley says

The Federal Reserve may begin to scale-down its $4.5tn balance sheet later this year as the central bank steps further away from financial crisis-era policies, William Dudley said on Friday.

The head of the New York Fed said in an interview with Bloomberg Radio that he does not expect the gradual normalisation of the central bank’s balance sheet to cause ructions in the financial markets since investors are already expecting the move.

Mr Dudley, whose views are thought to closely align with those of Fed chief Janet Yellen, said the process of winding down the balance sheet would be done in a “passive” way, and would be “running in the background”, meaning that short-term interest rates would still be the Feds’s primary tool for tightening monetary policy. He reckons the normalisation will either begin in late 2017 or next year, depending on how the economy performs.

He had said on Thursday evening that the best way to narrow the balance sheet would be to “taper reinvestments” of maturing securities “gradually and predictably”.

The Fed’s balance sheet swelled dramatically in the wake of the 2008 financial crisis as the central bank unleashed numerous rounds of bond purchases aimed at pushing down long-term interest rates in a bid to resuscitate the flagging economy.

Mr Dudley also echoed several other Fed colleagues this week in saying that he reckons the Fed’s policy-setting Federal Open Market Committee is in a “reasonable place”, and that a “couple more hikes this year seems reasonable”.

The Fed lifted its benchmark lending rate this month for the third time since the end of the financial crisis, but has projected two more increases this year given the strength of the labour market and uptick in inflation.