The Federal Reserve could begin shrinking its $4.5-trillion balance sheet as soon as this year, earlier than most economists expect, New York Fed President William Dudley said on Friday in the central bank's most definitive comments on the question that looms over financial markets.
"It wouldn't surprise me if some time later this year or some time in 2018, should the economy perform in line with our expectations, that we will start to gradually let the securities mature rather than reinvesting them," Dudley, among the most influential Fed policymakers, said on Bloomberg TV.
Economists polled by Reuters and by the Fed itself generally expect the U.S. central bank to begin shedding bonds from its portfolio some time next year, a move anticipated to depress bond prices. Dudley's hawkish-sounding comments pushed the dollar to a session low versus the Japanese yen on Friday.
The Fed amassed the record amount of mortgage and Treasury bonds in the wake of the 2007-2009 financial crisis in three rounds of "quantitative easing" meant to stimulate investment, hiring and economic growth. It is no longer buying additional bonds, but it is topping up the portfolio when assets mature.
The Fed's official plan is to begin letting the bonds naturally roll off - not sell them - once its interest rate hikes are "well underway". That is intended to shrink the portfolio to an unspecified lower level, though probably not to the pre-crisis level of around $900 billion.
Cleveland Fed President Loretta Mester and John Williams of the San Francisco Fed have also backed shrinking the portfolio this year. But Dudley is a very close ally of Fed Chair Janet Yellen and a permanent voting member of the Fed's policy committee, and his New York Fed manages the bond portfolio for the central bank.
Dudley said the bond run-off would be "passive" and done "in the background," though he added that it could influence the pace with which the Fed continues to raise rates.
"If we start to normalize the balance sheet, that's a substitute for short-term rate hikes because it would also work in the direction of tightening financial conditions," he said. "If and when we decide to begin to normalize the balance sheet we might actually decide at the same time to take a little pause in terms of raising short-term interest rates."
The central bank hiked rates a notch in mid-March, its second tightening in three months, and plans to move about twice more this year according to its forecasts.
(Reporting by Jonathan Spicer; Editing by Chizu Nomiyama)