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The Fed: Fed’s Mester says ‘markets can handle’ front-loading of rate hikes and balance sheet reduction at same time

Cleveland Federal Reserve President Loretta Mester on Wednesday said the Fed could continue “front-loading” interest rate hikes in the first half of this year and start to reduce the central bank’s balance sheet at the same time without causing financial market disruption.

“We have to recognize that inflation is very elevated. It is well above our goal. We have to do what we can with both our policy tools to get inflation under control,” Mester said, in a roundtable discussion with reporters.

“I think the markets can handle it. We just need to get on with that process,” she added.

Mester said Fed has communicated clearly what the balance sheet process would look like.

“Your question supposes that maybe the market can’t handle both raising interest rates and the balance sheet at the same time. But I think, given the situation we’re in, and the communications that chair Powell has already made about the balance sheet process, I don’t have concerns that would be destabilizing,” she said.

Mester is a voting member of the Fed’s interest rate committee in 2022. On Tuesday, she said she wanted the Fed to front-load” rate hikes in the beginning of the year and get the benchmark Fed funds policy rate up to 2.5% by the end of the year.

This projection presumes there will be “some” 50 basis point rate hikes during the year, she said.

Asked about the “yield curve” where short-term rates have risen close to longer-run Treasury yields, Mester said that long-term rates have been pushed down by a flight to quality when Russia invaded Ukraine.

One of the reasons to start reducing the Fed’s balance sheet is that the Fed doesn’t want to distort the yield curve by its actions.

“By reducing our balance sheet at the same time we’re raising the short rate, I think that has a good effect on not creating more distortion on the shape of the yield curve,” Mester said.

Stocks
DJIA,
-0.72%

SPX,
-0.47%

were lower on Wednesday. The yield on the 10-year Treasury note
TMUBMUSD10Y,
2.363%

slipped to 2.356%. The yield on the 2-year Treasury note
TMUBMUSD02Y,
2.154%

inched down to 2.146%.

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