(Bloomberg) — The US central bank’s decision to begin slowing the pace of its balance-sheet unwind gives policymakers more time to evaluate changes in market conditions and for liquidity to be redistributed within the banking system, according to Federal Reserve Bank of New York’s Roberto Perli.
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Although the Fed’s balance sheet has shrunk by over $1.5 trillion to $7.4 trillion since it embarked on the balance-sheet unwind almost two years ago — a process known as quantitative tightening, or QT — the level at which the Fed considers bank reserves to be ample is still uncertain, Perli said Wednesday. As a result, it makes sense to slowly approach that level.
“While implementation will not look much different, slowing runoff nonetheless represents an important and prudent step in the balance sheet reduction process,” Perli said in prepared remarks for the 2024 Annual Primary Dealer meeting in New York.
“Ultimately, I expect that this approach will allow money markets to continue to function smoothly with a lower level of reserve supply than would have been the case had runoff been allowed to proceed at its current pace for much longer,” he said.
The Fed last week 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.
Wednesday’s comments mark the first detailed remarks from Perli on the balance sheet since October.
Market participants have been wondering how much more Fed officials could shrink its 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.
Perli acknowledged that the effective fed funds rate — the central bank’s key policy benchmark — has remained “remarkably stable” and the market for repurchase agreements has only shown signs of occasional funding pressures, usually around month- and quarter-end periods and days when there’s large settlements of Treasury auctions.
While the reverse repo facility, or RRP, has absorbed virtually all of the Fed’s balance-sheet runoff, Perli noted that once it reaches zero or stabilizes at a low level, bank reserves will start declining one-for-one with the portfolio unwind, all else equal.
In the meantime, Perli noted policymakers continue to monitor a variety of metrics for any indication reserves have become ample. They include:
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The spread between fed funds and interest on reserve balances (IORB), which is currently negative 7 basis points, and is a clear sign reserves are still abundant.
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Total amount of federal funds borrowing domestic banks are doing as it suggests they’re using the market to meet funding needs.
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Outgoing interbank payments sent late in the day because once reserves are less abundant, banks are incentivized to delay outgoing payments to maintain higher reserve balances for a larger part of the day.
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Daylight overdrafts can help determine whether banks have enough reserves to process daily payment activity. When reserves are getting scarce, there are more mismatches between outgoing and incoming payments.
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