Federal Reserve

Dudley thinks the Fed could answer its $4.5 trillion question later this year

Fed's Dudley: After last hike, rates 'still unusually low'
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Fed's Dudley: After last hike, rates 'still unusually low'

The Federal Reserve could begin chipping away at its $4.5 trillion balance sheet later this year, New York Fed President William Dudley said Friday.

As the central bank continues down a gradual path of interest rate hikes, officials there also will have to contend with what to do with the bonds the Fed has amassed over the years of monetary policy aimed at juicing the economy.

Under current policy, when the bonds mature the Fed rolls them over and reinvests the profits. However, those days seem to be coming to an end.

"It wouldn't surprise me if sometime later this year or sometime in 2018, should the economy perform in line with our expectations, that we will gradually start to let securities mature rather than reinvest them," Dudley said in an interview with Bloomberg.

Investors care about the Fed's balance sheet because letting those bonds back into the market likely would boost supply and, with it, interest rates.

William Dudley, president of the Federal Reserve Bank of New York.
Mike Segar | Reuters

In fact, Dudley conceded that a balance sheet runoff would be the equivalent of rate hikes, and said that when the process begins the Federal Open Market Committee may well "take a pause in terms of raising."

However, he said he was not worried that the balance sheet runoff would be disruptive. Dudley figures the Fed will merely let the bonds mature, rather than actively seeking to sell them back into the market.

"If we do something on the balance sheet, it's going to be something that's very passive. It's just going to be running in the background," he said.

The Fed amassed much of its securities through three rounds of quantitative easing — a monthly bond-buying program that involved primarily Treasurys and mortgage-backed securities. The Fed currently holds nearly $2.5 trillion in Treasurys and another $1.8 trillion in MBS, along with a smattering of other holdings.

On the issue of interest rates, Dudley said two more hikes this year "seems reasonable." The Fed increased its benchmark short-term rate a quarter point on March 1. Traders currently anticipate that additional moves are likely in June and December.