In a recent speech, the official responsible for executing Federal Reserve monetary policy discussed the recent decision to slow the pace of reducing the central bank's balance sheet. This move is aimed at mitigating potential market stress and was described as a prudent step given the uncertainties surrounding the process. Roberto Perli, who manages the New York Fed’s System Open Market Account, emphasized the importance of managing the balance sheet contraction process carefully.
The Federal Reserve had previously announced its intention to decrease its holdings of Treasuries at a slower rate during the latest Federal Open Market Committee meeting. Since the summer of 2022, the Fed had been gradually reducing its holdings as part of efforts to tighten monetary policy.
Initially expanded in response to the pandemic, the Fed's balance sheet doubled in size to $9 trillion through aggressive purchases of Treasury and mortgage bonds. The monthly reduction had reached up to $95 billion, bringing the holdings down to $7.5 trillion. Following the recent FOMC meeting, officials announced adjustments to the runoff caps, with the Treasury bonds' pace reduced from $65 billion to $25 billion monthly. Chair Jerome Powell anticipates this change will result in approximately $40 billion in monthly balance sheet reduction.
The Fed aims to withdraw sufficient liquidity from the financial system to enable normal money market functioning and maintain control over the federal funds rate. By slowing the pace of reduction, the Fed seeks to prevent a repeat of the unexpected market stress experienced in September 2019 during previous balance sheet reduction efforts.
Perli noted that the ultimate size of the Fed’s balance sheet remains uncertain. A recent report from the New York Fed suggested that holdings may decline to between $6 trillion and $6.5 trillion based on market demand for bank reserves.
He also outlined indicators the Fed is monitoring to assess whether liquidity is tightening to a degree that warrants halting quantitative tightening (QT). These include monitoring domestic bank activity in federal funds, interbank payment timing, daylight overdraft amounts, and the share of repo volume trading at or above the interest on reserve balances rate.
Paraphrasing text from "Reuters" all rights reserved by the original author.
