‘Fed megaphone": the Fed is considering adjusting its balance sheet reduction plan to deal with the debt ceiling challenge
On 19 March, the Wall Street Journal's Nick Timiraos, ‘the Fed's sounding board’, reported that Federal Reserve officials will consider adjusting their policy of shrinking its $6.8 trillion asset holdings. For the past three years, the Fed has been shrinking its portfolio of US Treasuries and mortgage-backed securities accumulated in previous stimulus packages, including moves to stabilise markets during the 2020 epidemic.
For now, the Fed may choose to pause or slow down this tapering process. The move is intended to avoid a repeat of 2019, when balance sheet reductions led to tight overnight financing markets, forcing the Fed to turn to and expand its holdings.
Roberto Perli, the Fed's executive officer overseeing the balance sheet at the New York Fed, said this month that a pause in tapering would be a ‘tactical decision’ that ‘doesn't change the ultimate goal.’ Blake Gwinn, an interest rate strategist at RBC Capital Markets, noted that a pause in tapering makes sense because ‘the debt ceiling is going to distort those signals’.
Currently, the Fed allows up to $25 billion of Treasuries and $35 billion of mortgage-backed securities to mature each month without reinvestment. As holdings decrease, so do bank reserves. However, the debt ceiling issue could interfere with this process because the Fed is also the government's banker.
Analysts expect that the Fed may pause tapering until a few months after the debt ceiling is raised, and then resume when the Treasury rebuilds its cash balance, and Gwinn said that if the economy deteriorates, this ‘pause’ could also turn into a ‘halt’, prompting officials to end this form of policy tightening.
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