Federal Reserve Chair Jerome Powell announced on Wednesday that the central bank is nearing a decision to slow down the pace of its balance sheet reduction, commonly known as quantitative tightening (QT). Powell indicated that the Fed may ultimately reduce its bond holdings more than previously anticipated as it moves towards tapering the drawdown.
The decision to slow the pace of run-off is imminent, according to Powell’s statements during a press conference following a Federal Open Market Committee meeting. However, he did not specify a precise timeline for this action, stating that officials are currently deliberating on the matter.
The Fed’s efforts to shrink its balance sheet come in the wake of substantial asset purchases undertaken in response to the COVID-19 pandemic. Beginning in 2020, the Fed aggressively bought Treasury and mortgage bonds to stabilize financial markets and provide stimulus amid near-zero interest rates.
The resulting increase in Fed holdings more than doubled, reaching $9 trillion by mid-2022. However, the Fed initiated the reduction of its holdings later that year, coinciding with a campaign of interest rate hikes aimed at addressing high levels of inflation.
Since the fall of 2022, the Fed has allowed up to $60 billion per month in Treasuries and $35 billion per month in mortgage bonds to expire without replacement, resulting in a reduction of $1.4 trillion in Fed holdings.
The Fed’s objective in reducing its holdings is to ensure sufficient liquidity in the financial system while retaining control over interest rates. Powell emphasized the importance of avoiding excessive reductions in liquidity, citing the events of September 2019 when a previous QT effort inadvertently drained liquidity, causing interest rate fluctuations and prompting the Fed to expand its balance sheet once again.
By slowing the drawdown from its current pace, Powell suggested that the Fed may be able to achieve a greater reduction in its holdings without encountering significant disruptions. However, he cautioned that there is no straightforward rule to guide the cessation of QT.
While economists in a Reuters poll had anticipated the start of the QT taper process in June, recent developments suggesting ample liquidity in the financial system have raised the possibility of a later commencement of tapering.