By Michael S. Derby
NEW YORK (Reuters) - A Federal Reserve Bank of New York official who manages the implementation of monetary policy indicated Wednesday the central bank has room to further shrink its balance sheet, while noting government financial management issues will create challenges for the process over the short run.
Market indicators “are telling us that reserve conditions are currently abundant, as they have been for quite some time,” said Roberto Perli, who manages the Fed’s System Open Market Account, its portfolio of bonds, cash and other assets, which currently stand at $6.8 trillion. He spoke before a gathering of the Money Marketeers of New York University.
Perli’s comments suggest that all else being equal, there’s no imminent need to end the contraction of Fed holdings known as quantitative tightening, or QT. But with that said, there are some imminent challenges the Fed must navigate.
After more than doubling the size of its holdings due to efforts to bolster the economy during the COVID-19 pandemic, since 2022 the Fed has been allowing Treasury and mortgage bonds it owns to expire and not be replaced, which has allowed the central bank to trim just over $2 trillion from its holdings.
The Fed is trying to remove just enough liquidity from financial markets to allow for normal money market volatility and to preserve its strong control over the federal funds rate, its chief tool to achieve its monetary policy goals. The challenge for the Fed is that it is unsure where the stopping point for the drawdown rests.
Further complicating matters is unsettled government financial needs and a debt ceiling that limits borrowing. The Treasury’s effort to manage that situation is likely to lead to unsettled money market conditions, and as a result, Fed officials are contemplating slowing or temporarily pausing QT until more clarity arrives.
“The longer balance sheet runoff continues while the debt ceiling situation persists, the higher the risk that, upon the resolution of the debt ceiling, reserves could rapidly decline to levels that could result in considerable volatility in money markets,” Perli said, while not tipping his hand as to what he expects to happen with QT.
Speaking on Tuesday, New York Fed President John Williams said “our strategy hasn’t changed” and the endgame for QT remains in place. Slowing or pausing QT, if either happens, allows the Fed to “make sure” it doesn’t go too far with the drawdown and take out too much liquidity from financial markets, he said.
In his remarks, Perli also said he expects that the Fed’s overnight reverse repo facility can further shrink, while adding it’s possible the central bank will add morning Standing Repo Facility operations at the turn of the next quarter, as it did at year’s end. Perli also said repo market conditions, where banks and others borrow and lend bonds and cash, continue to normalize.
(Reporting by Michael S. Derby; Editing by Lisa Shumaker)