WASHINGTON — The Federal Reserve will begin slowing its balance sheet reduction campaign next month by limiting the number of Treasury securities it allows to roll off its books each month.
The Federal Open Market Committee, the central bank's monetary policy body, voted to begin tapering its balance sheet wind down campaign during its meeting this week. The process will begin by reducing the cap on Treasury redemptions from $60 billion monthly to $25 billion monthly. The change goes into effect on June 1.
Fed Chair Jerome Powell
"The decision to slow the pace of runoff does not mean that our balance sheet will ultimately shrink by less than it would have, but rather it allows us to approach this ultimate level more gradually," Powell said during his post-meeting press conference Wednesday. "In particular, slowing the pace of runoff will help ensure a smooth transition, reducing the possibility that money markets experienced stress, and thereby facilitating the ongoing decline of securities holding that are consistent with reaching the appropriate level of ample reserves."
When the Fed reduces assets — in this case by allowing Treasury securities to mature without replacing them — it mechanically reduces
Powell said the slower approach to balance sheet reduction is meant to avoid this outcome, adding that the move was called for in the Fed's balance sheet reduction plan, which was published at the start of the wind down campaign two years ago.
The Fed's monthly cap on balance sheet reduction is $95 billion, which includes a $35 billion cap on mortgage-backed securities. The Fed will continue to allow MBS to roll off its books at the current rate, though it will reinvest any principle that exceeds the $35 billion cap into Treasury securities — bolstering a view expressed by some Fed officials that the central bank might move to get out of the mortgage market altogether.
The Fed's balance sheet reduction campaign has reduced its holdings by nearly $2 trillion, bringing it down from its pandemic-era peak of $9 trillion to just north of $7 trillion as of this week.
Much of the reduction on the liabilities side has come from the Fed's overnight reverse repurchase agreement, or ON RRP, facility, which allows money market funds and other counterparties to park assets at the Fed overnight in exchange for a small amount of interest. Funds in the facility are broadly seen as excess liquidity in the financial system.
After remaining above $2 trillion for more than a year between the summers of 2022 and 2023, the facility has dipped below $500 billion, raising the specter that further balance sheet runoff could soon begin squeezing banks.
Powell and other officials have noted that while reserves remain "abundant" — above the "ample" volume that the Fed seeks to maintain — they are not distributed equally within the banking system, meaning some banks could experience scarcity before others.
During the meeting Wednesday, the FOMC voted to keep the target range for the federal funds rate between 5.25% and 5.5% again. The rate has remained at that level since last July.
The decision to hold the Fed's benchmark rate steady yet again was broadly expected by banks and other financial institutions. The move feeds rising doubts about whether the Fed will be able to ease its monetary policy significantly by year end, something that most market participants had taken as a given just a few weeks ago.
In its policy statement, the FOMC cited a "lack of further progress" toward its goal of sustained 2% inflation as a reason for keeping its policy rate unchanged. It also expressed measured pessimism about the prospect for easing monetary policy in the near term.
"The committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%," it said.
'No decisions' on capital proposal
During the press conference, Powell said the Fed Board of Governors has made no decision on how it will adjust the capital reform proposal it put forth last summer alongside the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency.
"First, let me say the Fed is committed to completing this process and carrying out our policy in a way that's faithful to Basel and also comparable to what the other large, comparable jurisdictions are doing," Powell said. "We haven't made any decisions on the policy or on process at all. Nothing. Nothing. No decisions have been made."
Earlier this year, Powell testified in front of Congress that the so-called Basel III endgame proposal will require "broad and material" changes and said he was open to the possibility of issuing an entirely new proposal, if the volume of alterations warranted that.
On Wednesday, he reiterated the board would not hesitate to repurpose, it deemed that appropriate.
Powell said the Fed is not obligated to resolve the rulemaking process for the Basel III endgame before moving ahead on other regulatory reforms — such as resolution planning and liquidity requirements — but the capital proposal remains the top regulatory priority.
"There's no mechanical rule in place there, but I would say that the Basel III process is by far the most important thing that is occupying us at this time," he said.
