(Reuters) – The Federal Reserve said on Wednesday it would begin eliminating assets from its $9 trillion balance sheet in June and will do so at nearly twice the pace of its previous exercise of “quantitative tightening.” as she faced four-decade-high inflation.
The central bank’s asset pool has roughly doubled in size during the coronavirus pandemic as it has used purchases of Treasuries and mortgage-backed securities to smooth market functioning and increase the effects of its interest rate cuts. Now he wants to reverse much of that, and in a relatively short time, alongside rate hikes designed to calm inflation.
Here’s a look at what’s in the cards now and how it differs from the 2017-2019 “QT” period.
The Fed’s announcement of the start of this QT cycle came in a single meeting after it raised its benchmark short-term interest rate for the first time since 2018.
In the previous episode, the launch of QT in the fall of 2017 came almost two years after the first rate hike of this cycle, which took place in December 2015.
This time, the start of the QT is also a little earlier relative to where the Fed is in its overall tightening process. In addition to announcing that QT will begin on June 1, the Fed on Wednesday raised its target rate to 0.75-1.00%. Last time QT didn’t start until rates reached 1.00-1.25%.
In September, the Fed will reduce $95 billion a month from its holdings, split between $60 billion in Treasuries and $35 billion in MBS.
This is roughly double the maximum pace of $50 billion per month targeted in the 2017-2019 cycle. At the time, the split was $30 billion in Treasury bills and $20 billion in MBS.
In the last cycle, it took a full year for the Fed to reach that maximum cut rate of $50 billion a month. It started with $10 billion per month ($6 billion treasuries / $4 billion MBS) and increased by $10 billion per quarter until it reached its maximum rate at the fall 2018.
This time it will go from zero to $95 billion in three months https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504b.htm, with only one first step before moving to the maximum rate of reduction . On June 1, it will launch the process at $47.5 billion per month for the first three months, split into $30 billion in Treasury bills and $17.5 billion in MBS. It will rise to $95 billion three months later.
BIGGEST BALANCE, BIGGEST LOSS
When the Fed launched its very first QT venture, its total balance sheet was around $4.5 trillion. In nearly two years of QT, he managed to reduce that figure from around $650 billion to just over $3.8 trillion before ending the program.
This time, the annualized monthly reduction rate amounts to more than $1.1 trillion per year in balance sheet declines once it reaches its maximum rate. This means it will likely exceed the total for the entire 2017-2019 QT cycle by early 2023. Many economists see officials aiming for around $3 trillion in total balance sheet reduction over a three-year period. years.
According to data from the New York Fed, the Fed’s Treasury portfolio this time has a shorter maturity than in the previous QT cycle of about two years. This is partly due to substantial purchases of Treasuries, particularly at the start of the crisis, to help restore market stability.
The plan released Wednesday said officials would rely on redemptions of Treasury bills, which mature in a year or less, when redemptions of coupon securities, which are notes and bonds with maturities longer than one year. year, is lower than the monthly ceiling.
Officials generally do not view treasury bills as a necessary part of their holdings necessary to ensure an adequate supply of reserves for the banking system under their current operation.
The Fed said it would slow and then halt the QT process when reserve balances in the banking system were “slightly above the level it deems consistent with ample reserves.” The Fed relies on a system of “abundant reserves” to conduct its policy, and QT will reduce this pool of funds, which are deposited by banks with the Fed.
In the previous QT cycle, it ended up reducing reserve levels too much, leading to disruptions in other short-term funding markets, an outcome it does not want to see repeated.
DO YOU SELL THESE HOLIDAY MORTGAGE BONDS?
Minutes from the Fed’s March meeting showed officials expect MBS redemptions to be below the cap of $35 billion per month. Indeed, mortgage interest rates in the United States have already risen significantly, slowing the pace of “prepayments” that typically occur when rates are low and homeowners have an incentive to refinance their existing loans. This triggers a loan repayment and shortens the term of a mortgage obligation. Conversely, when rates rise, fewer bonds will mature each month.
These minutes further showed that officials “generally agreed” that it would be appropriate to consider outright sales of MBS “after balance sheet liquidation was well underway to allow for appropriate progress towards a portfolio at longer term…composed primarily of Treasury securities”.
The plan announced Wednesday, however, made no reference to that possibility, and Fed Chairman Jerome Powell was not asked about it during his press conference.
(Reporting by Dan Burns; Editing by Andrea Ricci)
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