Will the Federal Reserve’s great bond runoff not amount to much?

Moderation was the watchword for the Fed as it announced its tightening regimen Wednesday. At the news that the federal funds rate would rise by only 0.5 percentage points—instead of the rumored 0.75—the stock market responded euphorically, though it gave back the gain this morning.

Meanwhile, bond yields didn’t move much. Why? One explanation: The amounts the Fed aims to trim from its swollen balance sheet—now standing at $8.9 trillion—were well-telegraphed, and Fed Chair Jerome Powell confirmed it yesterday. No one can be sure how much the Fed will boost the federal funds rate, but the balance sheet shrinkage appears less ambitious. That might remove some upward pressure for long-term rates.

When the pandemic hit, the Fed doubled the amount of Treasury bonds and agency mortgage-backed securities it held, buying gobs of them to lower long-term yields and thus make borrowing cheaper in a shocked 2020 economy. The Fed had done that once before, in response to the 2008 financial crisis. In 2018, when it tried to reverse the process and shrink the balance sheet, a political firestorm erupted, and it backed off.

Reducing the central bank’s bond holdings has “only happened one other time, and the Fed didn’t get too far before having to reverse course,” LPL Financial’s fixed-income strategist, Lawrence Gillum, has observed. “This time will go more smoothly.”

Powell said that the bond runoff will start in June, and left open how long it would run. For the first three months, it will allow $30 billion in Treasury bonds and $17.5 billion of agency mortgage-backed securities to mature each month, instead of rolling them over. After that, the pace will increase to $60 billion in Treasury bonds and $35 billion in MBS, or $95 billion per month.

That means a little more than $522 billion will leave the Fed balance sheet this year, bringing the total Fed bond holdings to $8.4 trillion at year-end. At a $95 billion monthly runoff rate going forward, it would take the Fed four years to return to the pre-pandemic balance sheet level of $4.2 trillion.

Long-term Treasury yields have been increasing, although hardly at a torrid tempo. The benchmark 10-year note is up just 1.3 percentage points this year, to a bit over 2.9%.