Today on Benchmark, we're going to talk about the Federal Reserve, America's central bank, which is about to embark on a huge policy step that's never been tried before on this scale. Did you know that the FED owns four point five trillion dollars worth of assets, including more than two trillion of Treasury bonds and one point eight trillion dollars of mortgage securities tied to the homes of people around the country, very possibly your own or that of someone you know.
The FED built up that stockpile as a way to help the U S economy during the global financial crisis and it's aftermath. Now it's about to take a major step by reducing that stockpile of assets. It might sound kind of technical, so why should you care. Well, it might make mortgage rates go up, it could make your vacation to Thailand a bit cheaper, and it could even make Donald Trump angry. I'm Scott Landman, an economics editor
with Bloomberg in Washington. Joining me today is Chris Condon, who covers the FED for US in d C. Hey, Chris, how's it going very well? Scott? So, Chris, we're recording this just a short while after the FED has issued the statement from its latest meeting, what did they do and what does it mean? Well, the new thing today is really just a small tweak in the language of their post meeting statement, but it means quite a lot.
Bottom line is it tells us that they're going to be reducing the size of this huge balance sheet beginning probably in October. But what do you mean by that reducing the balance sheet? What? How are they going to do this? And you know, what does it mean? Right right? I think the main word is very very carefully. They the FED ist kind of scared of its own shadow when it comes just reducing this. And by that I mean they've got this giant portfolio of bonds. In any
given month, certain number of those bonds are maturing. So say they hold a treasury, the Treasury sends them the money. When the bond matures, they get your principle back, just like any other investor up until now. The FED takes that money and reinvests it in the market, buys another Treasury security, So the size of their portfolio stays exactly the same, and the pressure that they're putting on yields
in that market stays exactly the same. In other words, the size of this balance sheet, these four point five trillion dollars in assets, it's like imagine a big weight on on a scale. It's kind of holding down interest rates in this country, which is the cost of mortgages, the cost to get a car loan, business moan, that sort of thing. It's just keeping that weight. And they're going to lessen that weight a little bit at a time, right, and they're gonna do that by letting some of these
bonds mature and not reinvest the returned principle. And in that way, they're essentially withdrawing money from the bond market. You withdraw money from the bond market, in yields go up. That is to say, the costs to these households and businesses to borrow money starts to go up, which is just what the Fed wants at this time, because the economy is doing a little bit better, and the Fed doesn't want to keep its foot on the gas pedal so hard. It wants to ease up a little so
that the economy can continue to grow without overheating. And so when this results in treasury yields going up, that will probably make the cost of mortgages, car loans and other kinds of credit go up as well. And that's actually a good sign for the economy. That means things are going well right, it does, it does as long as the stay in correct balance um that will help
prevent inflation from rising too rapidly. If if these interest rates go up a little bit um now, if they go too quickly, that could pull the rug out from under this recovery. And and indeed, like I said, the Fed is scared of its own shadow over this issue. A few years ago, Ben Bernanke really caused a flutter in the bond market when he only spoke about the possibility of slowing down the pace at which the Fed
was then buying bonds. They were still in the buying phase then, and he caught the market a little bit by surprise, and and there was a great reaction and yields flew up for quite for many months, called the Taper tantrum. That's our uninitiated listeners. And the Feed is was really scarred by that experience. So they have approached this entire action, which again they've never done before, with
the utmost of caution. That's why you've seen this very gradual, incremental approach, so even just communicating what it is they're going to do. Now, let's turn to one other aspect of this I was talking about at the top, how this could actually make your vacation to Thailand cheaper. How do we get how do we connect the dots from this action by the FED to making a vacation in
Southeast Asia a little less expensive. Well, it all has to do with how relatively attractive different investments are around the globe and the exchange rates between currencies. So any investor, a cross border investor, is going to look at, say an emerging market, and they're going to gauge the risk of investing there against the return they expect to get there compared to the return they'll get from a much safer asset like the bonds from an American company or
US treasuries. Now, when the FED raises rates or the FED begins to reduce the size of its balance sheet, the returns on treasuries and the bonds connected to US
companies will start to go up. So that makes them that that that squeezes that gap between the returns you can get abroad, maybe in some emerging market versus the returns you get from the safer assets and they're on the margin, makes those riskier countries a little bit less attractive, and then that makes their currencies a little less attractive
as well, right, Coral, that's right right now. The the secondary impact that they this can have on an emerging market is that there can be companies in these economies that are borrowing in dollars. Now as interest rates in the US go up, the dollar, if all other things
remain equal, will strengthen. Now, if a company is based in Malaysia and it's making its revenue you know, making shirts or whatever, or selling beer in the beach, and that is revenue is in the ring, get it's got to take that local currency revenue buy dollars and pay its dollar denominated loans off. That becomes more expensive as the dollar goes up and can put a lot of
pressure on emerging market countries companies. So, in other words, what's bad for the emerging market countries can be good for American consumers, especially those who enjoy traveling to Southeast Asia. That is true. So when exactly is this going to start happening? When is the FED going to start doing this? And how long is is this going to go on for Well, the first part is that it looks like
they're really on target to start in October. And the answer to the second part is, we really don't know yet. That's the one of the big questions they have yet to answer. They haven't told us when it comes to this quote unquote normalization of the balancy. They haven't told us what the new normal will be when they're done it. They're going to reduce it from four a half trillion to three and a half trillion or two two and a half trillion. It will make a big difference in
the lorman, but they haven't actually decided that yet. But basically, this is probably going to go on for several years, barring some kind of calamity or the recession that would cause the feed to re posies for sure. But remember now that they have said they're going to begin reducing it by only ten billion dollars a month. That will slowly go up over a year's time to fifty billion a month. But even a fifty billion a month takes a long time to roll off, say a trillion dollars.
In other words, they're kind of putting it on autopilot or as I like to say, it's like the showtime rotisserie oven from Ron Popel. Do you ever see that commercial? Chris? I think I have said it and forget it. That's what the FED is doing to its balance sheet policy here if it goes well. Right, we talked about how cautious they are when it comes to reacting to changing economic conditions. They still want their the FED Funds rate, the policy rate set by the FED, to be the
main tool for reacting. So if if inflation starts to go up and they decide they have to tighten, they'll raise the FED funds rate in reaction to that. They're not going to suddenly speed up the boundary. They want this balance sheet to go along a set course, get it running without disrupting the market, fingers crossed, and then just let it quietly run in the background. Right, So let's talk about the third thing I mentioned at the top,
which is President Donald Trump. Why might he not be too happy about this or even get angry about it? In President Trump's own words, I'm a low interest rate guy. Honestly, it's probably not fair to pick on him about this, because every president, once they're in office, is a low interest rate guy. Presidents are thinking about if they're in their a term of thinking about their reelection, what helps with their reelection where the economy is now or next
year right in the short term. The Fed thinks on a much longer term basis, and they may increased interest rates to head off trouble down the road. That won't police presidents, because they want to keep the economy juiced in running is as high as they can get it going before their their election. So and and let's not forget that rolling assets off the balance sheet. Reducing this balance sheet has the same ultimate effect. Maybe not is is large an impact, but it's in the same direction
as raising interest rates. It raises the costs of borrowing for households and companies. That slows down the economy on the margin. And so you might find at some point the president is critical of this. It is, to be honest, more likely that he's going to be critical of at an interest rate increase, because that is much more consequential in one swoop in terms of the credit market than
the balance sheet. Although there is kind of a sweep of strategy here, you have to you have to give some credit to the current FED chair Janet yell, And she's actually implementing a policy that is going to run for several years. And at the same time, her term is up in just a few months, and Trump is contemplating whether to reappoint her or replace her with someone else,
like his economic advisor Gary Khne. So she's actually doing something that is going to take away potentially some of the power of the next FED chair if it turns
out to be some someone other than her. Right, that's right, it's I don't think it's ever really possible to tie the next FED chairs hands completely, but it does make it more difficult if if they get off the blocks smoothly in reducing this balance sheet, and the process begins and it's going along and makes it very difficult for the next FED chair to come in and say, oh no, no, we've got to change this in one direction or the other,
say to slow down or speed it up. It's something that's working, and things that are working or in monetary policy are best left to themselves. One last question, can't we come up with some other name for this than balance sheet normalization? I mean, we had some other good shorthand names for other FED programs, like Operation Twist or QUEI that we're kind of pretty easy to remember, easy to communicate with the general public. Why can't they just
come up with something good here? Well, you mentioned qui if bond buying was, and that comes from the word the term quantitative easing. Um, So if that's a mouthful quant state of easing is que we could call this quantitative tightening or QT, because we know the FED wants to do it on the QT. Ha, that's a good one, Chris. That counts for funny in FED world. Well, let's see if that can stick in some of our stories. Chris Condon, it was great to have you on. Thanks for joining
us today to talk about the FED. My Pleasure Benchmark will be back next week and until then, you can find us on the Bloomberg terminal, Bloomberg dot com or Bloomberg app, as well as on Apple Podcasts, pocket casts, and Stitcher. While you're there, take a minute to rate and review the show so more listeners can find us and let us know what you thought of the show. You can follow me or tweet at me at at Scott Landman and Chris you are at Chris JA Condon.
Benchmark is produced by Sarah Patterson and The head of Bloomberg Podcasts is Alec McCabe. Thanks for listening, See you next time. Four