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The Federal Reserve has another option besides rate cuts to battle a slowdown

Key Points
  • The central bank could end the reduction of its balance sheet ahead of schedule, according to strategists from Ned Davis Research and Goldman Sachs.
  • Earlier this year, the Fed indicated it would end its balance-sheet reduction process by September.
  • Ending the process ahead of schedule would keep monetary conditions looser as more liquidity would remain in the system.
Federal Reserve Chairman Jerome Powell holds a news conference following a two-day Federal Open Market Committee meeting in Washington, June 19, 2019.
Kevin Lamarque | Reuters

The Federal Reserve signaled on Wednesday it could start cutting interest rates as soon as July. But the Fed also has another option up its sleeve.

The central bank could end the reduction of its balance sheet ahead of schedule, a move that would add further monetary stimulus to the U.S. economy, according to strategists from Ned Davis Research and Goldman Sachs. Earlier this year, the Fed indicated it would end its balance-sheet reduction process by September.

Ending the process ahead of schedule would keep monetary conditions looser as more liquidity would remain in the system. This would also help the central bank fend off an economic slowdown, along with rate cuts, and could lead to even more gains for stocks.

"It would be harder for the Fed to explain why they were cutting rates and letting the balance sheet continue to run-off," said Joseph Kalish, chief global macro strategist at Ned Davis Research, in a note. "That would be like pressing on the gas and the brakes at the same time."

The Fed amassed a whopping $4.5 trillion in Treasurys and mortgage-backed securities during and after the financial crisis. The move was part of the Fed's effort to stimulate the economy through a massive injection of cash. This was known as quantitative easing.

In October 2017, the central bank began to run off those assets on a monthly basis as it appeared the economy was on better footing. That process has been referred to by experts, and President Donald Trump, as "quantitative tightening." The Fed also hiked rates four times in 2018.

The Fed, however, reversed course on policy earlier this year after a string of weak economic data and lingering trade tensions between the U.S. and key partners like China and Mexico. The central bank had lowered its rates forecast from two rate hikes to zero prior to a two-day policy meeting earlier this week. On Wednesday, the Fed opened the door for rate cuts in 2019.

The central bank dropped the word "patient " from its policy statement, nodding to worries over slower economic growth, adding it will "act as appropriate" to sustain the economic expansion.

This could be a clue for investors the Fed will end its balance-sheet reduction process before September, said Jan Hatzius, chief U.S. economist at Goldman Sachs. That type of comment "usually presages policy action, " he said.

"Our reading of the meeting suggests that growth concerns are the primary justification, with low inflation lowering the hurdle required for Fed action," Hatzius said.

Stocks surged Thursday on hope the Fed would ease its monetary policy stance, lifting the S&P 500 to a record. The Dow Jones Industrial Average and Nasdaq Composite were also within striking distance of reaching all-time highs.

—CNBC's Jeff Cox contributed to this report.

Correction: The Fed had forecast two rate hikes in 2019 before lowering that forecast to zero. A previous version of this story misstated the number of rate increases. 

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