Don't Bet on Shaky Jobs Data Stalling Fed Action on $4.5 Trillion Balance Sheet

Its effect on a third rate hike this year is much less clear, however.
By James Langford ,

Perhaps the most obvious clue that August job growth was nothing spectacular was that President Donald Trump didn't tweet about it.

The real estate mogul who occupies the Oval Office found time to comment on social media site Twitter about plenty of other topics, from the stock market to a self-described record pace of accomplishments by his administration and his vanquished 2016 campaign opponent, Hillary Clinton.

But payroll gains 13% below economists' expectations and a 10 basis-point jump in the nation's unemployment rate didn't make a dent in the chief executive's stream-of-consciousness musings. Nor are they likely to impede the Federal Reserve's plans to start trimming a $4.5 trillion balance sheet, a move the central bank's monetary policy committee is expected to announce after its Sept. 19-20 meeting.

The effect on a potential interest-rate hike in December, which would be the third this year, is a much closer call, though Goldman Sachs Group Inc. (GS) - Get Report economist Jan Hatzius places the odds of an increase at about 55%.

The August report "may be somewhat less important than usual for the monetary policy outlook, because expectations were low, other U.S. growth data has been firm, and there are several months between now and December to make up for the weakness," he wrote in a note to clients.

The challenge for the Fed is that both raising interest rates and curbing its securities holdings tend to tighten economic conditions by taking away liquidity from financial markets. The securities portfolio more than quadrupled after 2008 as the central bank snapped up government debt and mortgage-backed securities to buoy economic conditions after near-zero interest rates failed to alleviate the impact of the financial crisis.

Now, with inflation of 1.4% still stubbornly below the Fed's 2% target -- and lower than four months ago, monetary policy committee members may be reluctant to move too quickly on both. If forced to choose between reducing the size of the balance sheet and the rate hike, Bank of America Corp. (BAC) - Get Report economists have said, they'll probably forego the increase.

Fed Governor Lael Brainard, a voting member of the committee, backed up that thesis during a speech in New York on Tuesday, Sept. 5.

"Once we set in motion the change in balance sheet policy, as long as the economy evolves broadly as expected, we should allow the balance sheet to run off in the background at the gradual pace that was announced," she said.

Afterward, however, "my own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target," Brainard noted.

To avoid spooking financial markets, the Fed has said it won't sell the securities in its portfolio but will instead gradually pare the amount of proceeds from maturing notes that it reinvests. The central bank will cap the total amount of securities that roll off each month at $10 billion initially, then raise the limit by the same amount every three months until it reaches $50 billion.

Investment bank Goldman Sachs has projected the central bank will ultimately shrink its balance sheet by just $1.1 trillion, or about 25%, a process that would take until late 2020.

The Fed will probably remain on track with starting the plan this month, despite the "modest negative" from the Sept. 1 jobs report, Joseph Song, a Bank of America economist, said in a note to clients.

A third hike, however, which would take short-term rates to a range of 1.25% to 1.5%, "will depend on wage and inflation data over the next several months," Song wrote.

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