By Michael S. Derby
WASHINGTON (Reuters) – The Federal Reserve said on Wednesday that it will reduce the pace of the drawdown of its still-massive balance sheet, as it faces challenges in assessing market liquidity during an ongoing impasse over lifting the government’s borrowing limit.
The announcement came as part of a Federal Open Market Committee meeting that left the central bank’s interest rate target unchanged, as officials deal with considerable uncertainty around the economic outlook tied to aggressive and often chaotic policy changes by the Trump administration.
The shift on the balance sheet had been hinted at in the meeting minutes for the January FOMC meeting, released last month.
The Fed said that as part of the reduction in the pace of quantitative tightening, or QT, the monthly cap of Treasuries that will be allowed to mature and not be replaced will be ratcheted down to $5 billion per month from the prior $25 billion monthly cap, effective on April 1. The mortgage-backed securities cap will hold steady at the current $35 billion limit.
Fed Governor Christopher Waller dissented against the shift in the balance sheet drawdown.
The Fed’s QT process has been running since 2022 and has been designed to strip from the financial system liquidity added during the COVID-19 pandemic and its immediate aftermath. To stabilize the financial system and provide stimulus, the Fed bought Treasury and mortgage bonds aggressively, more than doubling the size of its holding to a peak of $9 trillion.
QT has thus far helped the Fed shed just over $2 trillion from its balance sheet. Comments from Fed officials have suggested that all else being equal the financial system still has enough excess liquidity sloshing around that QT has some distance left to go.
The wrinkle in the effort is the debt ceiling, which limits how much the government can borrow. Faced with this roadblock, the Treasury is using cash from its account at the Fed to pay bills, which is adding liquidity into the system. When the debt ceiling is raised, assuming that happens, the Treasury will likely seek to rebuild its account, which will take liquidity back out of the system.
While this happens, Fed officials will have a very difficult time getting a true read on market liquidity. That complication means it’s hard for central bankers to know if they’ve taken out too much liquidity, and going too far could destabilize financial markets, as was the case with the last chapter of QT in September 2019.
Slowing/pausing QT allows the Fed the space it needs to move the process to its endgame smoothly. Pausing now, in the view of some analysts, could even allow the Fed to go farther with the drawdown, although they acknowledge restarting the process could be complicated and generate communications challenges with market participants.
(Reporting by Michael S. Derby; Editing by Chizu Nomiyama)
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