Fed’s George: Aggressive balance sheet reduction may allow shallower rate path

Kansas City Fed President Esther George said on Monday that the Federal Reserve can move sooner to start reducing its bond holdings than in the past and aggressive action to shrink the US central bank’s portfolio.

“What we do on the balance sheet will likely affect the path of policy rates and vice versa,” George said in remarks prepared for an event organized by the Economic Club of Indiana. “For example, more aggressive action on the balance sheet could allow for a shallower path for the policy rate.”

George said a different approach in which the central bank pairs a “steep path” for rate increases with more modest reductions to the balance sheet could lead to more financial risks.

She said such a scenario where the Fed is raising short-term interest rates while putting downward pressure on long-term yields through its bond holdings “could flatten the yield curve.” That could, in turn, lead to “reach-for-yield behaviour from long-duration investors.”

“All in all, it could be appropriate to move earlier on the balance sheet relative to the last tightening cycle,” George said.

As for market’s reaction, there has been no reaction to the comments in the market and the US dollar remains pressured on Monday, as investors consolidated gains ahead of the closely-watched monthly employment report later this week, Nonfarm Payrolls.

The US dollar has rallied to a 1-1/2-year high on Friday as investors take stock of the hawkishness at the Fed. The dollar index DXY was down 0.48% after George’s comments at 96.758, putting it on track for its largest daily fall since 12 January.