JPMorgan economist sees Fed shrinking balance sheet starting 2018

NEW YORK (Reuters) - A JPMorgan economist said on Thursday he expected the U.S. Federal Reserve to start paring the size of its $4.5 trillion (3.6 trillion pounds) balance sheet in early 2018 with a focus on ending its reinvestment in mortgage-backed securities. There has been growing speculation as to whether the U.S. central bank would soon consider reducing its bond holdings following three rounds of large-scale bond purchases or quantitative easing, one of the unconventional measures it used to combat the last recession. "In our baseline projection, the Fed slowly phases out MBS reinvestments beginning in the spring of next year, never halts reinvestments of Treasuries, never sells MBS, and reaches its new optimal size of the balance sheet in early 2024, with excess reserves in the banking system of $500 billion," JPMorgan economist Michael Feroli wrote in a research note. On March 22, the Fed had $2.46 trillion in Treasuries and $1.78 trillion in MBS. Several policymakers have raised concerns about the risks of the Fed maintaining the current level of its Treasuries and MBS holdings as it has remained on track to further increase short-term interest rates in the coming months. "While we see reinvestments phasing out early next year, we believe the Committee will want to formally agree on and communicate the plan sometime this year, perhaps by the summer or fall," wrote Feroli, referring to the central bank's Federal Open Market Committee, its policy-setting group. Fed's balance sheet is equivalent to 23 percent of the size of the U.S. economy compared with 6 percent prior to the global financial crisis more than eight years ago. Earlier Thursday, Goldman Sachs analysts said the Fed would shrink its balance sheet to 11 percent of U.S. gross domestic product or equivalent to $2 trillion, which could be achieved in late 2022. The FOMC will next meet on May 2-3. (Reporting by Richard Leong; Editing by Chizu Nomiyama; Editing by Chizu Nomiyama)