In his recent speech, Roberto Perli, the individual entrusted with executing Federal Reserve monetary policy, offered insights into the Fed’s strategic decision to decelerate the pace of reducing its balance sheet. Perli, who oversees the New York Fed’s System Open Market Account, portrayed the Fed’s announcement as a pivotal and judicious maneuver amidst a landscape fraught with uncertainties regarding its implications for market stability.
The Fed’s move, as decided at the latest Federal Open Market Committee meeting, involves a deliberate slowing down of the rate at which it allows Treasuries to diminish from its holdings. This strategic shift represents a departure from the prior aggressive contraction of its holdings, which commenced in the summer of 2022 as part of a broader strategy aimed at tightening monetary policy. Initially bolstering its holdings to $9 trillion in response to the pandemic through assertive bond purchases, the Fed gradually permitted up to $95 billion to runoff monthly, thereby reducing its holdings to $7.5 trillion. Chair Jerome Powell anticipates the revised approach to result in a monthly reduction of around $40 billion.
The primary rationale behind this recalibration is to strike a delicate equilibrium between withdrawing liquidity from the financial system to accommodate normal money market volatility and retaining control over the federal funds rate—a critical instrument for influencing economic momentum. By moderating the pace of balance sheet reduction, the Fed seeks to forestall a recurrence of the unforeseen market strains experienced in September 2019 during the final phase of balance sheet reduction.
Perli candidly acknowledges the prevailing uncertainty regarding the ultimate endpoint of the Fed’s balance sheet. While a recent report from the New York Fed posits that Fed holdings may decline to approximately $6 trillion to $6.5 trillion based on market demand for bank reserves, the precise figure remains elusive, underscoring the complexity of forecasting in dynamic economic environments.
To effectively monitor signs of tightening liquidity that could necessitate an adjustment to quantitative tightening (QT), Perli delineated a set of key indicators. These include scrutinizing domestic bank activity in federal funds, tracking interbank payment timing, monitoring daylight overdrafts, and assessing the proportion of repo volume trading at or above the interest on reserve balances rate.
In essence, the Fed’s decision to temper the pace of balance sheet reduction reflects a prudent and cautious approach, underscoring its commitment to preserving market stability while navigating the uncertainties inherent in monetary policy implementation. Perli’s address underscores the Fed’s vigilance in monitoring market dynamics and its readiness to adapt strategies in real-time to bolster economic resilience and stability.