Fed balance sheet reduction - A cautious approach

 

Yes, the Fed will start balance sheet reductions in May through roll-offs of their Treasury and MBS holdings with caps of $60 billion for Treasuries and $35 billion for MBS. If the roll-off in a given month is greater than the cap, then there will be reinvestment of the proceeds. Hence, the Fed will still be buying securities in selected months. 

We will note that the roll-off strategy will be less than the $120 billion of securities buying that occurred each month during the pandemic period. The roll-off will be slower than the purchases. 

If the Fed hits the cap each month, it will take 5.5 years to get back to February 2020 levels for Treasuries and a little over 3 years to get back to old MBS levels. In a rising interest rate environment, there will be less prepayment of mortgages, so the Fed may have to engage in actual sales to reach the cap levels. 

These reductions are almost double from the levels of the last QT of respectively $30 billion and $20 billion of Treasuries and MBS, but the balance sheet was half as large. 

The uncertainty concerning the Fed balance sheet reduction has been partially eliminated; however, it cannot be said that this is an aggressive policy given the high inflation and the size of the balance sheet. Given that the ON reverse repo open market operations are well over $1.6 trillion, the Fed could reduce the balance sheet faster and still have money funds looking for lending.   

The amount of Treasuries maturing in different maturity buckets based on 3/30/22: 

15 days          $89.5 billion

16-90 days     $316 billion

91-365 days   $761 billion

1-5 years       $2,198 billion

5-10 years    $999 billion 

10 years+    $1,400 billion