Fed officials weighed slowing or pausing bond drawdown at last policy meeting
UNCERTAINTY over how the US Treasury will manage debt issuance over the next few months drove some Federal Reserve officials to contemplate at their last policy meeting slowing or pausing the ongoing drawdown of their balance sheet until greater clarity arrived.
Fed officials, in minutes of the central bank’s Jan 28 to 29 Federal Open Market Committee (FOMC) meeting released on Wednesday (Feb 20), flagged the challenge of getting a clean read on market liquidity as the government wrangles over spending plans amid a legally mandated borrowing cap that will affect how the Treasury Department manages its cash.
“Regarding the potential for significant swings in reserves over coming months related to debt-ceiling dynamics, various participants noted that it may be appropriate to consider pausing or slowing balance sheet run-off until the resolution of this event,” the minutes noted.
Fed officials had already been bracing for a period of uncertainty due to government financial management, and had signalled in recent meeting minutes that it would be hard to know whether financial markets had enough or too little liquidity.
The issue is critical to the Fed’s ongoing effort to reduce its Treasury and mortgage bond holdings, in a process known as quantitative tightening, or QT. QT has thus far shaved just over US$2 trillion off Fed holdings, from a peak of US$9 trillion in 2022. Fed officials have viewed the process as largely technical and while it was started amid rate hikes, they have long argued that their bond-holding drawdown has little measurable impact on the financial system.
That said, they are uncertain where to stop QT and are closely looking at a range of market liquidity measures to gauge when the process should come to an end. Fed chair Jerome Powell noted last week that “I think we have a ways to go” on QT.
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But at the same time, losing the ability to read the market increases the risk of overshooting on QT, which could bring undesirable volatility to money markets, akin to what happened in September 2019, the last time the Fed was engaged in QT. That appears to be influencing at least some Fed officials’ thinking, even as the ultimate endgame for QT remains uncertain.
In an interview on Wednesday with Yahoo Finance, Atlanta Fed president Raphael Bostic said the Fed may be nearing levels where it can stop QT but said there was no precision on that. “I think it’s going to be appropriate for us to be more cautious today and moving forward than we have been in the past six or eight months” as this process plays out, he said.
The minutes cited the official who implements monetary policy at the New York Fed as cautioning that assessing market liquidity by way of bank reserves is going to be challenging.
The minutes said: “Reserves might decline quickly upon resolution of the debt limit and, at the current pace of balance sheet run-off, might potentially reach levels below those viewed by the Committee as appropriate.” If so, that could herald a swifter and more abrupt end to QT than what many in markets now expect.
Communications challenge
The idea of a pause has not been on the minds of forecasters who track Fed balance-sheet developments, and any such action could potentially represent a communications challenge for the central bank.
The meeting minutes also noted that even as Fed officials were debating the QT shift, market participants, in a survey conducted by the New York Fed ahead of the January FOMC meeting, saw a longer runway for QT. “In their expectations of Federal Reserve balance-sheet policy, survey respondents on average saw the process of run-off concluding by mid-2025, slightly later than they had previously expected,” the minutes noted.
The minutes also showed officials weighing what their holdings will look like after QT ends, amid a push to get overall holdings to a primarily Treasury-bond stance. “Many” Fed officials said they’d like to see the maturity of Fed bond holdings mirror the broader market, the minutes noted. REUTERS
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