By Michael S. Derby
(Reuters) -The Federal Reserve’s decision last month to announce a looming halt to the drawdown of its balance sheet earlier than many had expected drew broad support from central bankers, meeting minutes from the late October policy meeting released on Wednesday said.
“Almost all” policy makers favored the Fed’s plan to stop the drawdown on its balance sheet effective on Dec. 1, the minutes for the Oct. 28-29 Federal Open Market Committee meeting showed.
The document noted that
one official wanted an immediate stoppage of what has been called quantitative tightening, or QT. Fed Governor Stephen Miran acknowledged Wednesday in a speech that he was that dissenting vote.
QT was designed to remove excess liquidity from the financial system and bring it to levels that allowed the Fed firm control over its interest rate target, while allowing for normal market volatility. The Fed achieved those conditions in the run-up to the October FOMC meeting, as key short-term borrowing rates rose and some banks turned to the Fed for cash loans.
The end of QT came faster than many had expected coming out of the summer, although the minutes noted that market expectations about an end date were in flux as the FOMC meeting approached.
A New York Fed survey done ahead of the September FOMC predicted the runoff would end in the first quarter of 2026, although in dollar terms, the System Open Market Account, the central bank’s stock of bonds, was expected to settle around $6.2 trillion, which is close to where the SOMA is now.
DRAW DOWN
QT began in 2022 when the Fed began allowing Treasury and mortgage bonds it bought during the pandemic to run off and not be replaced. Bond purchases during the COVID-19 pandemic took the total size of the Fed’s balance sheet to a record $9 trillion, while QT has taken overall holdings to $6.6 trillion, well above the $4.1 trillion mark seen at the start of 2020.
In comments since the Fed meeting, officials have also signaled that some sort of modest Treasury bond buying will soon follow, to balance liquidity needs against a growing economy. Officials have stressed these purchases are technical and have no bearing on monetary policy.
The meeting minutes also showed that policymakers are thinking actively about moving more of their holdings over time into short-term Treasury bills to gain “flexibility” to deal with market liquidity needs.
BIG FOOT
The decision to halt QT leaves the Fed balance sheet much larger than where it was before the start of the pandemic, and dashes hopes that the central bank could have a more modest footprint in financial markets, at least in dollar terms.
Kansas City Fed President Jeffrey Schmid said in a speech last week that “a large balance sheet increases the Fed’s footprint in financial markets, distorts the price of duration and the slope of the yield curve, and potentially blurs the line between monetary and fiscal policy.”
But even so, he supported shutting down QT. Fed Vice Chair for supervision Michelle Bowman, who’d recently made a case for smaller Fed holdings, also did not formally oppose freezing the balance sheet either.
In a recent interview, Cleveland Fed leader Beth Hammack explained that as large as the Fed balance sheet appears in dollar terms, it is nevertheless the right size given the system the central bank uses to manage interest rates, joined with the economy’s currency needs and how the Treasury manages its cash.
“I don't really see a way of getting the balance sheet smaller unless you change from being in an ample reserves framework,” Hammack said on Nov. 6. “And I think the benefits of being in an ample reserves framework greatly outweigh the costs.”
William Dudley, who led the New York Fed until 2018 and managed the monetary policy implementation before that, said in a recent interview that, “I don't think the size of the Fed balance sheet is a problem.” He explained “you think about reserves at the Fed: No settlement risk, no liquidity risk. I mean, that seems like a good thing” for the financial system.
That said, Miran still thinks the Fed can get its holdings down again at some point in the future if it can lighten regulations on banks. He said, “we first have to get the regulations right and ensure that bank balance sheets are flexible enough for an environment with a smaller Federal Reserve footprint.”
The large size of the Fed’s balance sheet has also been a political issue. Treasury Secretary Scott Bessent has argued it distorts financial markets. Others have worried that large Fed holdings can push up inflation pressures.
Others have worried that a large balance sheet, given how the Fed manages interest rates, exposes the Fed to significant financial losses. Managing interest rates has created around $240 billion in red ink that the Fed must cover before it can start handing back profits to the Treasury.
(Reporting by Michael S. Derby; Editing by Chizu Nomiyama)
