By Ann Saphir
PALO ALTO, Calif. (Reuters) - With the U.S. economy facing significant headwinds, the Federal Reserve should align its balance sheet policy with its new "patient" approach to interest rates, San Francisco Federal Reserve Bank President Mary Daly said on Wednesday.
"We don't want the balance sheet to be working at cross purposes with our interest rate policy," Daly told the Stanford Institute for Economic Policy Research.
The Fed has been shrinking its $4 trillion balance sheet by as much as $50 billion a month for more than a year, which investors say has been tightening financial conditions even as the central bank last month signaled it is putting its three-year-long campaign to raise interest rates on hold.
Rising downside risks, including slowing global growth, tighter financial conditions and rising uncertainty over trade and other policies, justify that pause in rate hikes, Daly said on Wednesday.
And with U.S. interest rates now within a "hair's breadth" of neutral, Daly said she supports a halt on further increases until inflation rises sustainably to, or even above, the Fed's 2 percent target, or if there are signs of overheating in financial markets.
"Neutral" refers to rates that neither stimulate nor restrain growth.
And just as the Fed is adjusting its rates policy to financial and economic conditions, so too must it adjust its balance sheet policy, Daly suggested. "Those two are meant to work together and not at cross purposes," she said.
Indeed, minutes of the Fed's January policy meeting, released earlier on Wednesday, signaled that the Fed will soon announce plans to stop shrinking its balance sheet later this year, but in the meantime the runoff continues.
The Fed last month left its target range for short-term interest rates at 2.25 percent to 2.5 percent and said it would be "patient" in adjusting interest rates and would take economic and financial conditions into account in setting balance sheet policy.
Daly said on Wednesday that the U.S. economy is slowing faster than she had earlier thought - "self-bridling" she called it - but added that she believes its near-record-long expansion does not appear to be hitting a dead end.
"There's nothing on the radar that says we're slipping into recession," she said.
