Wall Street’s biggest banks have postponed the expected end of the Federal Reserve’s ongoing efforts to shrink the size of its balance sheet, according to the minutes of the Federal Reserve’s latest policy meeting.
Banks told the Fed ahead of its December policy meeting that they saw this process ending in June this year, slightly later than what they told the Fed ahead of its November policy meeting, the minutes of the December Federal Open Market Committee meeting stated , recounts a briefing by New York Fed officials responsible for implementing monetary policy.
The Fed’s most recent meeting, held Dec. 17-18, saw officials cut their interest rate target range by a quarter of a percentage point to between 4.25% and 4.5%, reduce expectations of future rate cuts, and raise their forecast path. inflation.
At the meeting, the Fed did not announce anything new regarding drawing down its balance sheet. But they made technical changes to the interest rates paid on reverse repo facilities to help encourage money market funds and other funds to move cash off the Fed’s books and into private markets.
The minutes’ update on the Fed’s balance sheet outlook comes as many look to 2025 as the year the central bank ends its efforts to reduce its holdings through a process known as quantitative tightening, or QT.
After more than doubling its holdings in 2022 due to a spate of aggressive bond buying sparked by the COVID-19 pandemic, the Fed has sought to unwind its Treasury and mortgage bond holdings to eliminate excess liquidity. This brought the Fed’s holdings from $9 trillion to just under $7 trillion.
In unwinding bonds, the Fed seeks to reduce the level of liquidity to the point where money markets can have a normal level of volatility and the central bank retains firm control over the range of the federal funds target interest rate, which is their primary tool for influencing economic momentum.
Ahead of the Fed’s November meeting, major banks told the New York Fed that they saw the QT process ending in May with Fed holdings of about $6.375 trillion. This would likely take banking sector reserves to $3.125 trillion, above the current level of $2.9 trillion.
The challenge for the Fed is that it is very difficult to know when a bank is releasing too much liquidity and if it exceeds that limit, it can result in significant market volatility, which the Fed wants to avoid in the current environment by slowing the pace of its balance sheet. sheet withdrawal.
Also hindering the Fed’s outlook is ongoing uncertainty around the government’s funding needs through the spring as Donald Trump returns as president. There were also some hiccups in the private repo market, which caused so much volatility at the end of the third quarter that some banks ended up using the Fed’s Standing Repo Facility, which provides quick cash funding to eligible companies.
The meeting minutes flagged a number of issues in the new year related to the Fed’s work on its balance sheet. It said that the return of the government’s borrowing debt limit could make it difficult for the Fed to assess liquidity conditions. Apart from that, the reintroduction of the debt limit could also make money continue to flow into the reverse repo facility because the issuance of government debt securities is likely to fall.
Source: Reuters
