© . FILE PHOTO: US Federal Reserve Chairman Jerome Powell testifies before a Senate Committee on Banking, Housing and Urban Affairs hearing on the “Semi-Annual Report on Monetary Policy to Congress” on Capitol Hill in Washington, US, March 3, 2022. REUT by Dan Burns () – The Federal Reserve on Wednesday indicated that at its meeting in early May it will likely begin clearing assets from its $9 trillion balance sheet and will do so in nearly twice as much as its previous “quantitative tightening” exercise as it faces inflation that is at a four-decade high. Minutes from last month’s central bank meeting, released Wednesday, showed that policymakers were presented with a range of options to reduce the size of the balance sheet. That stock of assets has roughly doubled during the coronavirus pandemic, as the Fed used purchases of Treasury bills and mortgage-backed securities to smooth market forces and amplify the effects of its rate cuts. Here’s a rundown of what seems to be in the cards and how it differs from the 2017-2019 “QT” period. EARLY START The Fed looks poised to kick off this QT round in just one meeting after raising its short-term benchmark for the first time since 2018. The last time QT launched in late 2017, almost two years after the first rate hike, which happened in December 2015. The start of QT this time is also earlier compared to where the Fed will be in the overall tightening process. If interest rate futures are a guideline, the Fed will raise its target rate to 0.75-1.00% in May, at the same time as QT kicks off. Last time, QT didn’t start until prices reached 1.00-1.25%. (Image: QT last time – https://graphics.reuters.com/USA-FED/QT/dwpkrqnnqvm/chart.png) LARGER CAPS Fed officials “generally agreed” on a plan to raise about $95 billion a year. month to cut its holdings, which include $60 billion in government bonds and $35 billion in MBS. That’s about double the maximum pace of $50 billion per month targeted for the 2017-2019 cycle. At the time, the split was $30 billion in government bonds and $20 billion in MBS. INCREASING FASTER In the last cycle, it took a full year for the Fed to hit its maximum rate of cut of $50 billion per month. It started at $10 billion per month ($6 billion Treasuries / $4 billion MBS) and increased that by $10 billion per quarter until it hit its maximum rate in the fall of 2018. This time, it will go from zero to $95 billion. in the space of three months…”or a little longer if market conditions warrant.” The minutes did not specify exactly how the limits would be “phased in,” a detail likely to be set out at the May 3-4 Federal Open Market Committee meeting that will launch the process. GREATER BALANCE SHEET, GREATER SHRINK When the Fed kicked off its very first QT venture, its total balance sheet was about $4.5 trillion. In nearly two years of QT, it managed to reduce that by about $650 billion to just over $3.8 trillion before shutting down the program. This time around, the monthly annualized reduction rate comes in at more than $1.1 trillion a year in deleveraging. That means it will likely surpass the total for the entire 2017-2019 QT cycle by the end of this year or early 2023. Many economists see officials targeting about $3 trillion in total balance sheet shrinkage over a three-year period. (Image: Fed balance sheet taking shape – https://graphics.reuters.com/USA-FED/BALANCESHEET/akvezjryopr/chart.png) (Image: Quantitative tightening and rate hikes – https://graphics.reuters.com/ USA-FED/QT/gdpzyjelrvw/chart.png) VARIOUS TREASURY MIX The maturity of the Fed’s treasury portfolio is about two years shorter this time than in the previous QT round, according to data from the New York Fed. This is partly due to the substantial purchases of T-bills, especially early in the crisis, to help restore market stability. The minutes showed that officials are monitoring the redemptions of Treasury bills, which mature in a year or less, while the redemptions of coupon securities, i.e. bonds and bonds with maturities over one year, are below the limit. T-bills are highly valued by retail investors and reducing their stock by the Fed would facilitate their issuance by the US Treasury Department. In addition, officials generally do not view T-bills as a necessary part of their holdings needed to ensure an ample supply of reserves for the banking system under their current operating framework. WHO SELL PERSONAL MORTGAGE BONDS? The minutes showed that officials expect MBS repayments to fall below the $35 billion per month limit. That’s because U.S. mortgage interest rates have already risen significantly, slowing the pace of “prepayments” that typically occur when rates are low and homeowners are tempted to refinance their existing loans. This causes a loan disbursement and shortens the term of a mortgage bond. Conversely, when interest rates rise, fewer bonds will mature each month. However, officials “generally agreed” that it would be appropriate to consider a full sale of MBS “after the deleveraging process was well underway to allow for appropriate progress towards a longer-term portfolio mainly consists of treasury bills’.
