(Bloomberg) — The Federal Reserve said it will shrink its balance sheet at a slower place beginning in June, reducing the amount of Treasuries it lets roll off every month, a step meant in part to ease potential strain on money-market rates.
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In the plan unveiled Wednesday, the Fed said it will lower the monthly cap on how much Treasuries it will allow to mature without being reinvested, to $25 billion from $60 billion, while keeping the cap for mortgage-backed securities unchanged at $35 billion.
Market observers had anticipated a reduction to a monthly cap of $30 billion for Treasuries. The lower-than-expected cap helped buoy government debt in the wake of the Fed’s announcement as it means an even smaller quantity of Treasuries will be sold to the public. Treasuries also rallied as the Fed left interest rates unchanged, as widely projected, and as Chair Jerome Powell said it was unlikely officials’ next move would be to tighten policy.
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With principal payments of agency securities currently running at about $15 billion per month, the total portfolio runoff will be about $40 billion per month, Powell said at a press conference.
“A decision to slow the pace of run-off does not mean that our balance sheet will ultimately shrink by less than it would otherwise, but rather allows us to approach its ultimate level more gradually,” he told reporters.
Read more: Fed Cites Lack of Progress on Inflation, Holds Rates Steady
The central bank has been winding down its holdings since June 2022 — a process known as quantitative tightening. It gradually increased the combined amount of Treasury and mortgage bonds it allowed to run off without being reinvested to a total of $95 billion per month.
Although most officials see the process as proceeding smoothly, they “broadly assessed” it would be appropriate to take a cautious approach to further runoff given the market turmoil seen in 2019, the last time the Fed tried to shrink its portfolio, according to the minutes from the Fed’s March meeting.
Market participants have been wondering how much more officials could shrink the Fed’s $7.4 trillion portfolio of assets before worrisome cracks — similar to those seen in 2019 ahead of an acute funding squeeze — start to appear. The Fed amassed the pile of debt as part of economic-stimulus measures during the pandemic.
But for now, short-term funding markets have been stable and stress-free. That gives officials flexibility and a positive backdrop as they consider the path ahead for QT.
If the Fed lets reserves shrink too much it risks triggering volatility in overnight funding markets similar to what was seen in September 2019. However, too many reserves consume bank capital and inhibit lending, and ensure the Fed maintains a large footprint in the Treasury cash and repo markets.
(Adds comments from Powell beginning in 5th paragraph.)
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