The Fed currently finds itself with a fairly major communication problem on its hands. This problem relates to changes in the size of its balance sheet and, more specifically, how those changes are being interpreted by the financial markets relative to how the Fed views them. We first became aware of the interpretation problem during the market's sharp "taper tantrum" in May 2013, when then Fed Chairman Bernanke announced that the agency would be slowing its asset purchases. It took the Fed through the summer and well into the autumn of that year to calm the situation. Since then, the Fed has taken great pains not to repeat this mistake. Yet, the financial markets still aren't fully buying into the Fed's views. Chairman Powell's comment that the Fed's balance sheet reduction program would be on "autopilot" was fairly innocuous, in that he was only repeating what the Fed has stated previously; however, the problem this time around was timing, coupled with the market's lingering sense that "balance sheet normalisation" is much more influential than the Fed is letting on. Given recent market and economic wobbles and the market's continued view that the balance sheet has a strong impact on its wellbeing, "autopilot" was exactly what the market did not want to hear. In this week’s Economics Weekly, we discuss the Fed's balance sheet, how the Fed believes the market should interpret changes to it versus how the market sees it, and what that means with regard to how we should be interpreting the "Powell pivot."
For a copy of this report or to subscribe to the Economics Weekly or Economic Indicators reports, please contact your William Blair representative.
Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.