After a two-day policy meeting, the Fed’s plan included two monetary policies to reign in the runaway pandemic-related economic stimulus: shrink their $9 trillion (!) portfolio and raise interest rates by 0.5%.
Typically, the Federal Reserve raises rates 0.25% at a time. However, runaway inflation means we are in drastic times. And drastic times call for drastic measures, leading to the 0.5% increase. After the hefty raise set off alarm bells among analysts, Powell assured nervous investors that an even more extreme increase of 0.75% was off the table.
Powell stated that shrinking the Fed’s portfolio will also act as a proxy for a further rate increase. The Federal Reserve’s balance sheet began to grow after low-interest rates during the Great Recession did not result in the desired economic stimulus. So the Federal Reserve began to pump cash into the economy by buying treasury bonds and mortgage-backed securities.
This tactic seemed to work and was used again during the COVID-19 pandemic. This time, though, it was used in conjunction with lowering interest rates right from the start. As a result, the Federal Reserve’s balance sheet grew to over $9 trillion in assets. Selling this part portfolio should result in cash flowing out of the economy, helping to curb inflation further.
With so much money on the line, the ripple effects through the economy will be significant and long-lasting. The Fed is aware of this and is evaluating the best timeline and method of dispersing the assets. It’s expected to be a gradual process over months or even years. Investors will need to follow along to see exactly how their assets will be affected and, perhaps, where opportunities present themselves.