The Fed is getting closer to ending the second part of its policy tightening

Published Thu, Feb 22 202411:58 AM ESTUpdated Thu, Feb 22 20242:26 PM EST

While most of the market's attention has been on interest rates, the Federal Reserve is quietly getting ready to loosen policy in another respect as it prepares to slow down the shedding of assets on its balance sheet. Policymakers at their January meeting appeared to have a brief discussion about when to wind down the reduction of the Fed's bond holdings, according to minutes released Wednesday . The meeting summary indicated that the rate-setting Federal Open Market Committee will take up the issue of when to unwind "quantitative tightening" in more depth at the March 19-20 meeting. Anticipation is building that a move could come sooner rather than later. Minutes showed "that the wheels are starting to turn on QT, with an in-depth discussion on balance sheet policy ahead in March that we think will prepare the ground for a decision in May to slow the pace of QT starting mid-year," wrote Krishna Guha, head of global policy and central bank strategy at Evercore ISI. That estimate hits close to other views on Wall Street. Goldman Sachs expects the balance sheet runoff will start in May and run until the first quarter of 2025, with the final stopping point determined by how the Fed judges the remaining level of reserves in the system. Deciding the future of QT likely will come down to "ample" versus "abundant," with the latter being a sign that the Fed can stop the roll-off, the firm's economists said in a recent note. As things stand, the Fed is allowing a capped level of maturing bond proceeds to roll off each month instead of reinvesting — $60 billion for Treasurys and another $35 billion in mortgage-backed agency securities. In practice, the average runoff has been $75 billion a month, or $20 billion below the capped level, primarily because of "very slow" prepayments of MBS, according to the New York Fed . Tapering down the roll-off could see the Fed reducing the caps in half, according to a projection from BNP Paribas. The QT program has resulted in a nearly $1.3 trillion reduction in total holdings, with the total balance sheet now standing at about $7.7 trillion. The Fed began the program in June 2022 as inflation surged and central bankers were forced into a scramble that saw monetary policy tightening hit a level not seen since the early 1980s. With confidence growing that inflation is easing, policymakers are looking to loosen up policy, albeit at a measured pace. Meeting minutes "suggest that the process may take longer to play out," BNP Paribas said in a note. Determining how aggressive the reduction will be and how long it will take will come down to a judgment about the level of reserves in the system. "We're getting to that time where questions are beginning to come into greater focus about the pace of runoff and all that. So at this meeting, we did have some discussion of the balance sheet, and we're planning to begin in-depth discussions of balance sheet issues at our next meeting in March," Chair Jerome Powell said in his January post-meeting news conference . "So those, those questions are all coming into scope now, and we're focusing on them. But we're, we're at the beginning of that process, I would say." The current level is considered ample and totals around $3.5 trillion, about double where it was before the Covid pandemic when the Fed quickly eased policy, slashing rates and instituting the bond-buying program. On top of that, the Fed has kept an active overnight reverse repurchase operation going, though demand has fallen sharply, from more than $2.5 trillion in late 2022 to about $575 billion as of Wednesday.