The Federal Reserve has been selling bonds it purchased to pull the economy out of the financial crisis. Now, it has begun preparing for what could be an early end to this program.
In turn, the move also could lead to fewer interest rate hikes than the central bank is currently forecasting.
At stake is the size of the Fed's balance sheet where it holds the Treasurys and mortgage-backed securities it bought during three rounds of stimulus that began in late-2008 and concluded in October 2016.
Where once Fed officials believed the balance sheet would shrink from about $4.5 trillion to a range of $2.5 trillion to $3 trillion, the required level may be considerably higher, depending on how much in reserves the banking system will need to remain liquid. Reducing the bond holdings results in a decrease in reserves.
No central bank in the world has ever attempted a balance sheet reduction on this scale, so the skill to which the Fed can pull it off is critical.
As the Fed has been continuing the program, financial markets have tightened and may require a quicker exit from the program than officials had figured. Markets had been anticipating that the program would run for several more years, but Wall Street pros are now considering a much sooner end.
"Our risk scenario to excess reserves ... suggests the balance sheet could be 'normalized' by summer next year," BNP Paribas said in a research note Wednesday. "The Fed is making and will likely need to make further changes as liquidity evolves to remain in control of money market rates."