The Fed also said it will stop shrinking its balance sheet on Dec. 1. The change in language comes after Fed Chair Powell said earlier this month that the Fed may be approaching the point in the coming months where policymakers can stop their balance sheet runoff, or the allowance of bonds to mature and roll off the Fed’s portfolio, thereby decreasing the size of its balance sheet. Powell noted at the time that some signs have started to emerge that liquidity conditions are gradually tightening, and the committee wants to avoid the kind of strains in money markets experienced in September 2019.
Both the rate cut and the change in the direction of liquidity (neutral vs contraction) should be a moderate boost to risk. We all knew the rate cut was going to happen but I did not expect them to change course on the balance sheet (which I think is less necessary - and I wish they told us if this decision was divided like the rate cut was).
As a reminder, the Fed balance sheet is still $2 TRILLION MORE (roughly a 50% increase) than it was pre-covid. If they can’t shrink that back down after three years of growth, I don’t think they ever will.
Yes and no. Compared to 10 years ago in October 2015, the Fed’s balance sheet is 47% larger. However, we need to adjust that for inflation, which was 36%. Thus, in real dollars the increase was
1.47/1.36 = 8%,
less than 1% a year. If the Fed keeps its balance sheet steady then in three years (with 3% inflation) the real balance will be the same as it was 10 years ago.
What a wonderfully careful, polarized, eggheaded discussion. Threads like this keep me coming back for another episode of “As the Economy Turns!”
I am currently in Spain, where my surviving long time drinking friends (now in their 80’s and one is 91!, but were my best coaches in speaking spontaneous Spanish, albeit with Catalan inflections) at the leftist Bar Unio tell me that they survived Franco and that all is now well, and so never mind (or mind too much) about the current USA Caudillo. I tell them I am now more than half Mexican, and that throws them into laughter and calls to give the yanqui another cerveza.
@Hawkwin I don’t the Fed will shrink its balance sheet from where it is now. Yesterday, the WSJ published an article explaining that the Fed maintains “ample reserves” for the banks and money markets in order to control short-term interest rates, primarily the federal funds rate. Recently there were some inklings that the demands for their reserves were getting close to the limits so liquidity might have been constrained. That would have caused the fed funds rate to rise without the Fed intending it to.
The Fed doesn’t want to take that chance. As long as their strategy is “ample reserves” they will maintain their balance sheet.
Here is a description of the ample reserves regime.
The Fed buys Treasury debt as the existing bonds mature. The maturity of the Treasury debt will influence the bond market returns at longer maturities than the overnight fed funds rate.
Don’t view Fed’s balance sheet in isolation. It should be viewed along with Federal government’s deficit, the size bank reserves, etc. Today Fed balance sheet at $6.6 T is < $7.6 T in money market funds. The market is too tight, even a simple $50 M loan write-off by Zion, caused the rates to spike. Fed needs to maintain a certain size of balance sheet because overall bank reserves, MM funds, have all grown in size.
The Fed, market, economists have a decent idea of how QE works, but they have very little idea of how QT works. This QT is done during a unusually high inflation, and sudden tariff’s across the board. We don’t even know, whether Fed has gone too far (personally, I think it is).
