Large questions about the pace of inflation’s decline and the timing of interest rate cuts claimed most Wall Street attention about the Federal Reserve’s meeting this week. But equally significant was the news about decreasing the Fed’s bond holdings.
Fed Chair Jerome Powell announced at the body’s Wednesday news briefing that policymakers would slow the balance sheet’s two-year reduction drive “fairly soon.” A slowdown in the reduction would ease one source of upward pressure on interest rates—which would benefit borrowers and the banking system.
Powell cautioned that a total end to the bond “runoff”—allowing a segment of bonds to mature and not re-investing the proceeds in new bonds—was not imminent, just that its slower pace would be easier for the financial system to get used to.
The stock market greeted word of the Fed’s announcements by jumping about 1% on the three major U.S. market indexes.
The Fed began enlarging its balance sheet in June 2020, around the time it started lowering the fed funds rate. Buying Treasury bonds and mortgage-backed securities from public markets, the central bank injected cash into the economy to counteract the pandemic’s financial toll, thus helping keep rates low, a process called quantitative easing or QE. The Fed’s balance sheet doubled to $9 trillion by 2022.
Higher inflation prompted the Fed to reverse course. In mid-2022, as the Fed commenced to raise rates, it also pulled back on re-investing the principal of matured Treasurys and MBS, a policy called quantitative tightening. Since then, the Fed’s balance sheet has slimmed down by around $1.4 trillion, to $7.6 trillion.
At his briefing, Powell would not pinpoint any certain time the Fed would slow its runoff pace, saying “the words fairly soon mean fairly soon.” Letting the balance sheet shed bonds has involved running off $95 billion in Treasurys and $35 billion in agency mortgage-backed securities.
Powell argued that “inflation is still too high,” but added that the Consumer Price Index and the Fed’s favorite gauge, the Personal Consumption Expenditures Price Index, have continued downward despite some “bumps in the road,” namely slightly higher readings in January and February than in previous months. On Wednesday, the Fed kept its benchmark short-term rate, the fed funds rate, stable at a range of 5.25% to 5.5%; the central bank has held it at that level since the last hike in July 2023.
The Fed’s target rate for inflation is 2.0% annually, and the its policymaking committee indicated in the economics projections released Wednesday that inflation would not get there until 2026. The panel also estimated that the U.S. gross domestic product would rise 2.1% in 2024 and 2.0% in each of the ensuing years. (GDP increased 3.1% in 2023.) The projections remained for the central bank to cut the fed funds rate three times this year.
Tags: balance sheet, Federal Reserve, Inflation, Jerome Powell, mortgage-backed securities, quantitative easing, quantitative tightening, Treasurys
