NEW YORK (Reuters) - The U.S. Federal Reserve could resort to outright asset sales to reduce its balance sheet as part of plans to fight unabated inflation, a Credit Suisse (SIX:CSGN) analyst said in a report.
The Fed's balance sheet roughly doubled in size during the pandemic to nearly $9 trillion, as it snapped up bonds to help keep longer-term interest rates down to support the economy.
But this has led to rising inflation, excessive leverage, and high valuations in certain segments of the stock market.
Previous rounds of "quantitative tightening", a reversal of the Fed's bond-buying programme, were slow-going, but this time around the Fed may move more aggressively, Credit Suisse analyst Zoltan Pozsar said in a report late last week.
"Last time, QT was meant to be like 'watching paint dry' – slow and steady ... This time around, QT is more about scraping the paint off the wall – the fresco painted during the first two years of the pandemic is out of date", he said.
The last time the Fed embarked on shrinking its balance, sheet in 2018, it did so by allowing a number of bonds to mature without the repaid principal being reinvested in new securities.
This time, "outright asset sales, if inflation, exuberance, or a curve inversion so dictate, are not at all unlikely", Pozsar said.
He added that liquidity will likely be drained from reserve balances in bank portfolios and from overnight reverse repurchase balances in money market funds.
Demand for the Fed’s reverse repo facility surged last year as financial firms struggled to find places to invest their excess cash.
Investors are focusing on a Fed policy meeting this week, and will be looking for clues on whether the U.S. central bank will speed up the end of its bond purchase program, and on when it is likely to begin reducing the size of its balance sheet.