NY Fed's Williams: Balance Sheet Run-off Could Start As Soon As May

The Federal Reserve may begin trimming its balance sheet as soon as its May 3-4 meeting to address inflation risks that have become "particularly acute," New York Fed chair John Williams said Saturday.

With Fed rate increases underway and expected to continue, Williams, who also holds the title of vice chair and is a permanent voter on monetary policy, flagged the likelihood the central bank will now begin tightening financial conditions through a second channel by letting its nearly $9 trillion portfolio of Treasury bonds and mortgage backed securities decline each month.

"This process of reducing the size of the balance sheet can begin as soon as the May (Federal Open Market Committee) meeting," Williams said in remarks to a symposium at Princeton University's Griswold Center for Economic Policy Studies.

He cited inflation running at 6.5%, more than triple the Fed's 2% target, as the central bank's "greatest challenge," with inflation potentially driven higher by the war in Ukraine, the ongoing pandemic, and continued labor and supply shortages in the U.S.

"Uncertainty about the economic outlook remains extraordinarily high, and risks to the inflation outlook are particularly acute," Williams said.

However, he said he expected the combination of rate increases and balance sheet reduction to help ease inflation to around 4% this year, and "close to our 2 percent longer-run goal in 2024" while keeping the economy on track.

"These actions should enable us to manage the proverbial soft landing in a way that maintains a sustained strong economy and labor market," Williams said. "Both are well positioned to withstand tighter monetary policy."

The Fed increased its short-term federal funds rate in March by a quarter of a percentage point, and is expected to continue with rate increases at each of its six remaining meetings this year. Some Fed officials have advocated larger half-point increases to further tighten credit and act against inflation.

Williams did not address that issue in his prepared remarks, but has earlier said he would be open to the idea depending on how economic data evolve.

Decreasing the size of the balance sheet, however, provides a second method of tightening credit. As the Fed's stock of asset holdings decline, it puts upward pressure on Treasury bond and mortgage rates.