What will the Fed do next?

This is an interesting chart. It is supposed to highlight the situation the Federal Reserve is now in with regard to the size of its balance sheet and the what it might do next – raise short-term rates or reduce the size of its balance sheet.

Obviously its holdings are very large, but I was somewhat surprised to see how large it was in the 1930’s and 1940’s. It’s clearly larger in nominal terms. But relative to the size of the economy or adjusted for inflation it has to be significantly smaller.

It is also somewhat surprising to realize that it has been nearly 10 years since the yield on the 10 year US Treasury note was above 5%. Clearly the move over the last several months from 1.5% to 2.5% is quite significant on a relative basis but on a nominal basis – it is still quite low historically.

What will the Fed do? Good Question!

For the last couple of years, its been suggested that rates will start to move up. Obviously that didn’t happen, but I would suggest this might be the year we see high short-term interest rates.

On the other hand, maybe they will work on their balance sheet. This could have a bigger impact on longer term rates than short-term rates.

Either or both of these actions would not surprise me. The real question relates to magnitude, to which I will plead ignorance.