If you’re looking for a wild card out of this week’s Federal Reserve meeting, forget about interest rates and focus on the balance sheet. The run-off of the Fed’s $7.6 trillion in holdings of Treasurys, mortgage-backed securities (MBS) and other assets could soon be set for a tapering and ultimately a halt. During his post-meeting news conference Wednesday, Fed Chair Jerome Powell could drop some hints about how the process will unfold. At the Fed’s last meeting in late January, Powell indicated the topic will come up at this meeting. With little surprise in store on interest rates, the approach to the central bank’s balance sheet could provide some intrigue. The focus will hone in on when the tapering begins, and how quickly the Fed moves to unwind what is colloquially known as “quantitative tightening,” or QT. The Fed currently is allowing up to $60 billion a month in Treasurys roll off its balance sheet without being reinvested, along with up to $35 billion in MBS, a level that almost never comes into play. Mark Zandi, chief economist at Moody’s Analytics, sees “QT winding down beginning in June with the first rate cut, and they’ll kind of taper it down so that it ends at the start of 2025, and at that point, they’ll have $7 trillion in assets.” On a timetable basis, that’s right around the unofficial Wall Street consensus. Both Bank of America and Goldman Sachs expect the process to start sooner, in May, and then continue into the first quarter of 2025. The idea is that the monetary regime will go from one of ample bank reserves down to something less than that. The two firms both see the level of roll-off for Treasurys sliced to $30 billion a month, with Goldman putting the end point of the process when the balance sheet is down to $6.7 trillion. The move coincides with less demand for the Fed’s overnight reverse repo facility, an integral liquidity measure as banks maneuvered through the Covid-era economy. Demand for so-called ON RRP peaked at more than $2.5 trillion in late 2022 and has now fallen to $447 billion this week. “Risks to our base case skew to a later slow down of QT & longer QT period. We have overweighted Dallas Fed President Logan’s guidance that the Fed would slow QT when ON RRP balances reach a ‘low level,'” wrote BofA rates strategist Mark Cabana. “If the Fed signals a later QT slowdown than we expect it will contribute to modest upward pressure on money market rates & result in higher bill supply vs our base case.” While there’s no guarantee the Fed will disclose its balance sheet plans, Powell almost certainly will face questioning at his post-meeting news conference. Before the Fed commenced QT in June 2022, Powell took the unusual step of advising the public and the media to read the minutes of the preceding meeting for information on how the process would be conducted. Zandi said he expects Powell could take the same approach this time.
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