Fed meeting: Jerome Powell says balance sheet drawdown taper coming soon

Fed meeting: The Federal Reserve is nearing a decision on slowing the pace of its balance sheet run-off, central bank Chair Jerome Powell said on Wednesday, a tapering move that may allow it to shed more bonds than it once expected. Powell's remarks, the most explicit so far about plans to slow a process that has seen about $1.4 trillion of bonds roll off the Fed's balance sheet, was seen by several Wall Street analysts as a signal that a tapering plan will be unveiled as early as the Fed's next meeting on April 30-May 1.

"It will be appropriate to slow the pace of run-off fairly soon," Powell said at a press conference following a Federal Open Market Committee meeting. He did not offer a specific time frame for the decision, saying only that officials are now debating the issue. Powell was addressing the central bank's ongoing efforts to reduce the size of its holdings, commonly referred to as quantitative tightening, or QT.

Officials aggressively increased the central bank’s balance sheet as part of the response to the coronavirus pandemic. Starting in the spring of 2020, the Fed bought Treasury and mortgage bonds in great numbers, first to stabilize financial markets and then to provide stimulus when the Fed’s interest rate target was at near zero levels and could be cut no further.

That quantitative easing, or QE, caused Fed holdings to more than double, topping out at $9 trillion by the summer of 2022. The Fed began to shrink the size of its holdings later that year, having embarked in March 2022 on what would be a robust campaign of interest rate increases aimed at bringing high levels of inflation back to its 2 per cent target.

Since the fall of 2022 the Fed has been allowing up to $60 billion per month in Treasuries and $35 billion per month in mortgage bonds to expire and not be replaced. The Fed is seeking to reduce the size of its holdings in a way that will ensure the financial system has enough liquidity for the Fed to retain firm control over the federal funds rate, its chief tool to influence the economy’s momentum, and to allow for normal levels of volatility in money market rates.

To achieve that, Fed officials have been signaling for some time that they would first lay out a plan to slow, or taper, the pace of QT given uncertainty over how far they’ll need to shrink their overall holdings. Officials are mindful of the events of September 2019, when a QT effort then in play unexpectedly drew too much liquidity out of the financial system, causing significant interest rate churn, requiring the Fed to add liquidity back by once again expanding its balance sheet.

Thomas Simons, economist at investment bank Jefferies, said in a note that Powell’s comments may have moved forward the start of the tapering process. “We had been thinking that the tapering of QT would begin in June or July, but this guidance suggests that perhaps the announcement could come sooner, possibly the next meeting on May 1,” he wrote.
Simons' view was echoed by others.

"We now expect the Fed may make this announcement as early as the May FOMC meeting, ahead of our previous expectation of a June announcement," Tiffany Wilding, managing director and economist at PIMCO, said in a note. In his press conference, Powell said slowing the drawdown from its current pace may allow the central bank to compress the size of its holdings by a greater degree. "We may actually be able to get to a lower level because we would avoid the kind of frictions" that might happen by shedding bonds too quickly, he said.

Powell noted the endgame for Fed holdings envisions a level of banking sector liquidity that's large enough to navigate normal volatility and periods of stress. But he cautioned there's no easy rule-of-thumb for stopping QT, saying "there's not a dollar amount or percent of GDP or anything like that" to look to. Ahead of the FOMC meeting, a bare majority of economists in a Reuters poll had been expecting the QT taper process to begin in June and wrap up early next year.