Minutes from the Federal Open Market Committee (FOMC) January meeting show that although members unanimously agreed on the need to shrink reserves, division remains over how and when to dispose of mortgage assets as the voices of concern on impending inflation are rising to a chorus. In January, the FOMC said the Federal Reserve is on track to buy $1.25trn agency mortgage-backed-securities (MBS) from Freddie Mac (FRE), Fannie Mae (FNM) and Ginnie Mae by the end of Q110. The Fed has continued to slow MBS purchases ahead of a targeted March 31 completion date, to prepare the private investment market to step back into a leading demand role. Fed chairman Ben Bernanke said last week a series of policy wind-down methods are being tested. The Fed may first drain excess reserves built up over many months through extraordinary asset-purchase programs, and then begin to raise the target for the federal funds rate. Or the Fed could pursue both options simultaneous to facilitate a quicker exit. FOMC members echoed these plans to exit the Fed's accommodation policies. Among the options discussed was selling mortgage securities before they mature, which would not only shrink the supply of reserve balances, but also the Fed's balance sheet. Most members favored "some extent" of reserve draining before raising the target federal funds rate from its current 0-0.25% range, although several members thought draining operations might be seen as a precursor to tightening and should only be used soon before an increase in the target rate. Members were "unanimous" on the need to shrink the supply of reserve balances and the Fed's balance sheet significantly over time, possibly through redeeming and not replacing agency debt and MBS as the securities mature or prepay. Members disagreed on asset sales, with most favoring gradual sales at some point in the future and others expressing concerned that the sales could disrupt the market in a time when economic recovery is not yet self-sustaining. Several members favored selling assets sooner to shrink the Fed's balance sheet in a more fast and predictable way than simply redeeming maturing securities and not reinvesting prepayments. "[T]hey judged that a program of asset sales spread over a number of years would underscore the Committee's determination to exit from the period of exceptionally accommodating monetary policy in a manner and at a pace that would keep inflation contained without having large effects on asset prices or market interest rates," FOMC said in the minutes from the January meeting, released Wednesday. Philadelphia Federal Reserve Bank president and CEO Charles Plosser this week voiced his support for selling assets. "I would favor our beginning to sell some of the agency mortgage-backed securities from our portfolio rather than relying only on redemptions of these assets," he said in a speech. "Doing so would help extricate the Fed from the realm of fiscal policy and housing finance." Other FOMC members suggested a compromise, adjusting the pace of asset sales - and potentially purchases - over time as market conditions demand. The FOMC did not make any policy decisions regarding asset sales, but it did decide to keep the target for the federal funds rate at the 0-0.25% range. Kansas Federal Reserve Bank president Thomas Hoenig voted against keeping the rates so low "for an extended period," suggesting instead to keep rates low "for some time," giving the FOMC flexibility to begin raising rates modestly. He indicate that "under these improving conditions, maintaining short-term interest rates near zero for an extended period of time would lay the groundwork for future financial imbalances and risk an increase in inflation expectations," according to the minutes. And inflation on wholesale prices looks to be rising already, with the Producer Price Index coming in 1.4% higher in January on energy costs, which soared 6.9% from December, according to the latest from the Bureaur of Labor Statistics. Unemployment claims look to be rising in February, with initial unemployment insurance claims coming in 31,000 higher than the previous week, to 473,000 in the week ending February 13, according to the US Department of Labor. The prolonged high unemployment and under-employment rates are adding to the wave of poor mortgage payment performance and foreclosure. Some media reports are going so far as to suggest a "perfect storm" of unemployment and foreclosure is pressuring homeless rates in rural and suburban America. Write to Diana Golobay.