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Forex

Greenback seen climbing on speculation of Fed unloading assets

Haunted by past mistake, central bank may take cautious tack

TOKYO -- Speculation that the U.S. Federal Reserve will shrink its balance sheet in the near term may stoke yen-selling pressure against the dollar once again.

The greenback began weakening around the time of President Donald Trump's inauguration Jan. 20. His trade policies and criticism of the dollar as too strong helped drive the yen to the 112 range.

But selling of the greenback did not last long, said a currency dealer at a European bank, who sees positive American economic indicators propping up the dollar at this stage.

The market is starting to consider a possible move by the Fed to shrink its balance sheet and how this would strengthen the dollar even further.

Despite the Fed ending its third round of quantitative easing in the autumn of 2014, outstanding holdings come to about $4.5 trillion. It keeps reinvesting maturing Treasury bonds and mortgage-backed securities. The Fed apparently repurchased some $300 billion of assets in 2015 alone.

If the Fed stops reinvesting, it will signal a tightening in both the quantitative and the qualitative planks of the easy-money policy. The only question remaining is when that day will come.

A survey of primary dealers, released in December by the Federal Reserve Bank of New York, pegged 1.38% as the median expected federal funds rate level triggering a change in the reinvestment policy. Philadelphia Fed President Patrick Harker also said the U.S. central bank should think about stopping reinvestment once the policy rate reaches 1%.

Many at the Fed believe that the funds rate should be raised three times this year from the current range of between 0.5% and 0.75%. In this scenario, there will be a case for halting reinvestment in 2017.

The average interest rate on Fed assets hovers at around 2.5% to 3%, according to a Bank of Japan veteran. Some speculate whether the U.S. central bank will move to shed holdings early to avoid losses.

But the Fed will likely approach the issue of terminating reinvestment cautiously. Back in May 2013, when it was snapping up $85 billion a month in assets in the third round of quantitative easing, then-Chairman Ben Bernanke hinted that the bulk purchasing might shrink in scale. This led to a bond market slide that impacted the larger international market, especially in emerging countries.

The blame fell on the Fed's exit strategy from the third quantitative easing, which slated rate hikes after a reinvestment freeze. In 2014, the central bank promoted rate hikes to the first priority.

Perhaps recalling the lessons of 2013, Bernanke blogged Thursday that "there's no need to rush" the process of shrinking the balance sheet.

This sentiment is also echoed in the market. "An early tightening is not the main scenario," said Kenta Inoue, senior market economist at Mitsubishi UFJ Morgan Stanley Securities.

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