By Michael S. Derby
NEW YORK (Reuters) - Meeting minutes from the Federal Reserve's most recent policy gathering showed that the decision then to moderate the pace of the balance sheet drawdown was not unanimous.
"Almost all participants expressed support for the decision to begin to slow the pace of decline of the Federal Reserve’s securities holdings in June," said the minutes of the April 30-May 1 Federal Open Market Committee gathering, released Wednesday.
"A few participants indicated that they could have supported a continuation of the current pace of balance sheet runoff at this time or a slightly higher redemption cap on Treasury securities than was decided upon," the minutes said. The document also showed that "a few" FOMC members said the caps in place at the meeting weren't being met in any case.
The meeting minutes add further detail to a plan announced by the Fed at the start of the month to reduce the pace of its balance sheet contraction widely known as quantitative tightening, or QT, as a means to reduce the risk of market stress and potentially allow holdings to be reduced by more than if the prior pace of run off was maintained.
As part of that FOMC meeting the Fed said the monthly draw down in Treasuries would fall from a $60 billion per month cap to $25 billion. The Fed maintained the mortgage run off cap at $35 billion per month, a level it has already struggled to achieve given conditions in the housing sector. Fed Chair Jerome Powell said then he’s expecting to see about $40 billion per month in run off when the new plan goes into effect at the start of June.
Most Fed officials who have spoken publicly on the outlook for QT have spoken favorably about slowing the process down. However, Kansas City Fed President Jeff Schmid said in a May 14 speech that he understood the Fed decision while noting "I would still reconfirm my preference to shrink the balance sheet as much as possible consistent with the Fed’s current operating framework."
REVERSE GEAR
After doubling holdings from the onset of the coronavirus pandemic four years ago, the Fed has since 2022 been allowing Treasuries and mortgage bonds to mature and not be replaced. The run up in the balance sheet was aimed at calming markets and providing stimulus beyond the near-zero interest rate policy imposed by the Fed in March 2020.
The Fed began raising rates to tackle high inflation in the spring of 2022, and later that year it started allowing bonds it owned to mature and not be replaced, in a bid to withdraw what it viewed as excessive market liquidity. That’s taken overall Fed holdings from $9 trillion to the current $7.4 trillion.
Fed officials remain uncertain about the ultimate size of Fed holdings. Officials are aiming to have enough liquidity in the system to allow for normal market rate volatility and firm control over the federal funds rate, their main monetary policy tool.
“The purpose of slowing the pace of reduction of the balance sheet is completely to smooth this process for us, to be able to better monitor and to understand what's happening with the demand for reserves and the ampleness of the supply of reserves,” New York Fed President John Williams told Reuters on May 15. “It gives financial institutions time to gradually adjust to changing market conditions,” he added.
A recent New York Fed report projected that depending on market demand for reserves the balance sheet could settle somewhere between $6 trillion and $6.5 trillion at some point potentially in 2025.
Recent remarks from Roberto Perli, a New York Fed official responsible for implementing monetary policy, noted the process of the drawdown has been smooth so far. He also laid out guideposts for what the Fed is watching to gauge market liquidity levels.
Perli said he’s keeping an eye on “domestic bank activity in federal funds, the timing of interbank payments, the amount of daylight overdrafts, and the share of repo volume trading at or above the [interest on reserve balances]” rate.