Why the Fed's balance sheet reduction won't slam the economy

The official unwinding of quantitative easing (QE), which was put in place during the financial crisis to stimulate the economy, isn’t expected to be disruptive to growth.

“The outlook for the US economy is brighter than it’s been in some time, which should allow the Fed to walk back policy accommodation without upsetting the applecart,” according to AllianceBernstein’s Eric Winograd.

On Wednesday, the Fed announced it would begin to unwind its $4.5 trillion balance sheet, beginning the path to “normalizing” what has been accommodative monetary policy.

Strong economic backdrop

Winograd explained that the US economy is on strong footing, highlighting strong consumption trends, which is key since household expenditures account for two-thirds of GDP.

“A resilient labor market gives households plenty of income to fuel consumption. And confidence is near cyclical highs, so it seems likely that households will keep the money flowing for the next few quarters,” he wrote.

Meanwhile, Winograd pointed out that business investment has started to rebound. And the depreciating dollar along with low interest rates have further supported investment.

“A weaker dollar provides tailwinds for exporters and manufacturers—reflected in a surge in survey-based measures of manufacturing activity,” Winograd wrote. “[B]ond yields are low, giving businesses and consumers access to low-cost financing to fund investment and consumption.”

Meanwhile, the rest of the world is also strong.

“Globally, the picture looks brighter than it has in some time,” Winograd wrote. “GDP is stable or rising in the developed world, and major emerging markets—including China—are also running at a good clip.”

This broad-based strength also means there is a higher likelihood that other central banks will be moving in the same direction as the Fed, he said. With policymakers in other countries also paring back accommodative policies, there will be less friction than when the Fed was alone in its normalization path.

Furthermore, there’s potential economic upside. Winograd pointed to the potential passage of any of President Trump’s pro-growth agenda items, including tax reform and infrastructure investment.

It’s also worth mentioning that these well-telegraphed moves to normalize monetary policy will happen very slowly, further limiting any negative impact.

“At just $10 billion per month initially, the pace of run-down will be so gradual that it is unlikely to have a major impact on the economy or financial markets,” according to Capital Economics.

Nicole Sinclair is markets correspondent at Yahoo Finance

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