Fed officials see benchmark rate becoming ‘volatile’ during balance sheet run-off

The benchmark that the Federal Reserve uses to set interest rates could become more volatile as the central bank continues to unwind the portfolio of bonds on its balance sheet.

Fed officials conducted further discussions about the impact of balance sheet reduction at their December meeting, with members noting the work it will take to make the operation proceed smoothly, according to minutes released Wednesday.

The Fed ran its balance sheet, comprised mostly of Treasurys and mortgage-backed securities, up to $4.5 trillion in operations during and after the financial crisis in an effort to lower interest rates and stimulate the economy.

At present, the central bank is allowing $50 billion a month in proceeds it gets from the bonds to run off the balance sheet, and is reinvesting the rest.

While officials have said they see the operation progressing smoothly, the mechanics are getting complicated.

The meeting summary reflected sentiment that as the balance sheet declines and bank reserves fall, the federal funds rate, which banks charge each other for overnight lending but also serves as a barometer for adjustable-rate consumer debt, may rise above the interest the Fed pays on excess reserves.