Fed prepares to slash size of swollen balance sheet by $95bn a month

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The Federal Reserve is set to start shedding $95bn of assets a month from its swollen $9tn balance sheet as it steps up efforts to curb soaring inflation in the US.

An account of the Federal Open Market Committees last meeting in March showed officials finalising a plan to reduce the central bank’s presence in US government bond markets.

The central bank’s footprint in debt markets expanded significantly during the pandemic as it hoovered up trillions of dollars of Treasuries and agency mortgage-backed securities in an attempt to stave off an economic cataclysm.

But faced with persistently high inflation, the Fed is trying to tighten monetary policy, and reducing the size of its balance sheet is the main lever it can pull to cool down the economy after interest rate rises.

According to the minutes of the March meeting, officials broadly support the Fed increasing the pace at which it pares back its asset holdings over the coming months via a process known as “run-off”, whereby the central banks stops reinvesting the proceeds from maturing securities.

Members of the FOMC broadly agreed on monthly caps of about $60bn for Treasuries and $35bn for agency MBS, phased in over a period of three months or “modestly longer if market conditions warrant”. That amounts to asset reductions of just less than $1tn a year.

The minutes show central bankers want to shrink the balance sheet quickly, and much more swiftly than the previous attempt to shed assets in 2017 after the Fed’s holdings had ballooned due to bond-buying in the wake of the global financial crisis that started in 2008.

Back then, the Fed capped the monthly reduction in its balance sheet at $50bn and took a year to reach that pace.

Lael Brainard, a governor who is awaiting Senate confirmation to become the Fed’s next vice-chair, on Tuesday said the reduction would be “rapid” and could commence as soon as its next policy meeting in May.

She said a quick response was justified given the degree to which inflation is overshooting the central bank’s 2 per cent target and the strength of the labour market.

Jay Powell, Fed chair, has previously suggested that the expected pace of balance sheet reduction this year is roughly equivalent to a one quarter-point interest rate increase.

Line chart of Assets held by the Federal Reserve, $tn showing Fed plans “rapid” reduction of balance sheet

Minutes from the March meeting also showed officials were open to more aggressive rate rises this year to battle rising prices following its decision to raise the federal funds rate by a quarter of a percentage point for the first time since 2018.

That could include raising the federal funds rate by half-point increments in order to bring it to a “neutral” level that neither speeds up or slows down growth this year. Officials estimate that rate to be between 2.3 and 2.5 per cent.

In the weeks since the meeting, at which a majority of officials signalled the policy rate should rise to 1.9 per cent in 2022, policymakers have assumed an even more hawkish stance.

Mary Daly, president of the San Francisco Fed, told the Financial Times on Friday that the case for a half-point rate increase at the May meeting had grown, echoing a number of her colleagues who have in recent weeks signalled their support for a faster and more forceful tightening of monetary policy.

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