Federal Reserve may start shrinking balance sheet in May, Lael Brainard says

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Federal Reserve's plan to shrink its balance sheet will contribute to the central bank's monetary policy "over and above the expected increases in the policy rate," Fed Governor Lael Brainard said in a speech at the Minneapolis Fed on Tuesday.

The balance sheet reduction could start "at a rapid pace as soon as" the Federal Open Market Committee's May meeting, she said. "Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–19," she said, according to her prepared remarks.

The balance sheet reduction combined with the expected rate increases should bring the Fed's policy rate to a "more neutral position later this year," Brainard said. Additional tightening over time will depend on how the outlook for inflation and employment evolves, she added.

Her comments also suggest that the FOMC is open to raising rates by more than the standard 25 basis points per meeting. "Currently, inflation is much too high and is subject to upside risks," Brainard said. "The committee is prepared to take stronger action if indicators of inflation and inflation expectations indicate that such action is warranted."

Note that last month, Fed Chair Jerome Powell has said he'd support a 50-bp rate hike if it was appropriate.

She concluded: "We are committed to bringing inflation back down to its 2 percent target, recognizing that stable low inflation is vital to maintaining a strong economy and a labor market that works for everyone."

Last week, Neel Kashkari, who's known as one of the more dovish FOMC members, said he has penciled in seven rate hikes for this year.