Fed ties rate hike to economic rebound, sees balance sheet cuts in 2017

WASHINGTON (Reuters) - Federal Reserve policymakers agreed they should hold off on raising interest rates until it was clear a recent U.S. economic slowdown was temporary, though most said a hike was coming soon, minutes from their last policy meeting showed on Wednesday.

FILE PHOTO: A man walks past the Federal Reserve Bank in Washington, D.C., U.S. December 16, 2015. REUTERS/Kevin Lamarque/File Photo

Nearly all policymakers at the May 2-3 meeting also said they favored beginning the wind-down of the U.S. central bank’s massive holdings of Treasury debt and mortgage-backed securities this year.

While investors continue to see a rate increase as highly likely next month, the minutes showed that the Fed’s rate-setting committee “generally” believed it hinged on the economy rebounding from its sharp slowdown in the first quarter.

“Members generally judged that it would be prudent to await additional evidence indicating that a recent slowdown in the pace of economic activity had been transitory before taking another step in removing accommodation,” according to the minutes, which provided the latest indication of the Fed’s heightened caution over policy tightening.

Still, Fed officials made it clear they expected the economy to pick up momentum.

U.S. stocks briefly pared gains and the U.S. dollar .DXY fell against a basket of currencies after the minutes were released. Yields on U.S. Treasury debt turned lower.

“They left June open. I think they would move in June, followed by a fourth-quarter hike,” said Matt Toms, chief investment officer of fixed income at Voya Investment Management in Atlanta.

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Fed policymakers also discussed at length the reasons for the first-quarter slowdown and why a measure of underlying price gains also fell further below their 2 percent inflation target, according to the minutes.

A wider group of policymakers including officials who aren’t voting on the rate-setting committee this year said they expected a rate increase would be needed soon, and reviewed a Fed staff proposal on reducing the central bank’s balance sheet.

The Fed has more than $4 trillion in Treasury debt and mortgage-backed securities, largely accumulated as part of the effort to stimulate the economy in the wake of the 2007-2009 recession.

The staff proposal, presented as a “possible operational approach” to winding down the balance sheet, entails halting reinvestments of ever-larger amounts of maturing securities.

Under the plan, a limit would be set on the amount of securities allowed to fall off the balance sheet every month. Initially, the cap would be set at a low level, but every three months the Fed would allow deeper cuts.

“Nearly all policymakers expressed a favorable view of this general approach,” the minutes said.

Reporting by Jason Lange and Howard Schneider; Editing by Paul Simao