Fed Chair Powell Signals Balance Sheet Will Grow Soon After Recent Market Turmoil

on Oct9
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DENVER — The Federal Reserve chair, Jerome H. Powell, said on Tuesday that the central bank would again begin expanding its portfolio of government-backed securities and continued to leave the door open to another interest rate cut this month.

While “policy is not on a preset course,” Mr. Powell said, the Fed will “act as appropriate to support continued growth.”

Mr. Powell, speaking at an economics conference in Denver, emphasized that the Fed’s next meeting was a few weeks away. He said officials were monitoring weaker global growth and uncertainties arising from trade tensions and Britain’s negotiations to leave the European Union.

While he demurred on whether the Fed will cut interest rates for a third time since July, he offered the clearest signal yet that the Fed will soon buy Treasury securities to expand its balance sheet.

The central bank has been saying for months that it will eventually need to expand its holdings again to keep an ample supply of banking reserves — currency deposits at the Fed — in the financial system.

“That time is now upon us,” Mr. Powell said. He added that the Fed “will soon announce measures to add to the supply of reserves over time.”

Last month, an obscure but important corner of financial markets — overnight repurchase agreements made between banks and other financial institutions — saw a spike in interest rates that spilled into other money market rates. It even briefly pushed the federal funds rate, the Fed’s main policy tool, above its range.

The episode prompted the Federal Reserve Bank of New York to jump into the market to smooth things over for the first time since the financial crisis. Many market observers have said that might not have been necessary had the central bank kept a bigger balance sheet. By shrinking its asset holdings, the Fed also drained bank reserves from the financial system.

While several factors could have contributed to the episode, “it is clear that without a sufficient quantity of reserves in the banking system, even routine increases in funding pressures can lead to outsized movements in money market interest rates,” Mr. Powell said in his remarks.

President Trump’s regular criticism of the central bank risks further clouding that message. The president has spent months calling for interest rate cuts and an end to balance sheet shrinking. While the Fed operates independently of the White House and officials say their moves are based on economic developments and not politics, there is a risk that some onlookers will believe the central bank has capitulated to Mr. Trump.

The Fed has cut interest rates twice since July as trade uncertainty weighs on business investment and a global manufacturing slowdown hits American factories. While officials often repeat that the United States economy is solid, changes to interest rates take time to filter though the economy. Policymakers set them with an eye toward how future growth appears to be shaping up — not just how the data looks today.

Risks to that outlook have been running high. Germany’s economy seems to be on the brink of a recession, and China’s has been weakening. While Chinese trade negotiators are in Washington this week, it remains unclear whether a comprehensive resolution to the trade war can be reached. Britain’s negotiations to exit the European Union are reportedly on shaky ground.

Signs are also mounting that the United States economy may be slowing. Job gains have cooled off, and wage growth seems to have plateaued. Indexes gauging both manufacturing and services have weakened. Despite that, Mr. Powell painted an optimistic picture of the current state of the economy on Tuesday.

“There have been periods where the economy has slowed, and kind of gathered itself,” like in 1995, 1998 and even 2016, Mr. Powell said, adding that “it seems to be a healthy thing.”

“Clearly, things are slowing a bit now” but “it may just be gathering itself,” he said. “There’s no reason why the expansion can’t continue.”

He called the jobs and inflation pictures “favorable” and said that “many indicators show a historically strong labor market, with solid job gains, the unemployment rate at half-century lows and rising prime-age labor force participation.”

Still, he added, “there are risks to this favorable outlook, principally from global developments.”



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