Source: Wall Street News

The Federal Reserve is making more noise about removing quantitative austerity (QT) in the future. The latest signal comes from the New York Federal Reserve, which manages the Federal Reserve's open market operating accounts.

In the Open Market Operation Annual Report released on Wednesday, April 17, EST, the New York Federal Reserve predicts that the Fed's QT action to reduce its balance sheet (downsizing) will end in 2025, or next year. The report puts forward two hypothetical scenarios relating to QT. It is expected that QT may end in the beginning or middle of next year. After that, the amount of reserves that banks deposit into the Federal Reserve will be reduced to 2.5 trillion or 3.0 trillion US dollars.

The report predicts that under a high level of reserves, the size of the Federal Reserve's balance sheet will be reduced to about 6.5 trillion US dollars, and under a situation where reserves are low, the balance sheet will drop to 6 trillion US dollars.

Furthermore, the New York Federal Reserve predicts that due to the increase in the cost of the Federal Reserve's interest-bearing debt, the net income of the Federal Reserve's bond portfolio may still be negative this year, and will return to positive values in the next few years. Wall Street News mentioned that due to the “side effects” of interest rate hikes, the Federal Reserve's operating loss reached 114.3 billion US dollars last year, setting a record for the highest loss of the year. This kind of loss is a floating loss. It does not affect the operation of the Federal Reserve, but it will exacerbate the already huge US government fiscal deficit. When to resume profits depends on when interest rates are cut this year and beyond.

The minutes suggest that the Federal Reserve is preparing to start slowing down soon Wall Street expects the monthly reduction limit on US Treasury bonds to be cut in half

The Federal Reserve began downsizing in June 2022, and is currently maintaining the pace of contraction of US Treasury bonds and institutional mortgage-backed securities (MBS) of up to $95 billion per month. The Federal Reserve meeting last month did not make any changes to the downsizing action, but the minutes released earlier this month show that at last month's meeting, the Fed policymakers discussed the consideration of slowing down the pace of downsizing, and most people tend to start slowing down soon. The minutes read,

The participating Federal Reserve officials believed that the downsizing was progressing smoothly. “Despite this, considering the experience of ending the downsizing from 2017 to 2019, participants still generally agree that it is appropriate to take a cautious approach to further downsizing. Therefore, the vast majority (vast majority) of participants believed that it would be prudent to start slowing down the downsizing soon (soon).”

The minutes revealed that officials attending the Federal Reserve last month generally agreed to reduce the recent overall monthly bond downsizing scale by about half, and there is a general tendency to slow down the downsizing rate by maintaining the current upper limit of institutional MBS and adjusting the redemption limit for US Treasury bonds. This means that the future downsizing will slow down mainly through a reduction in the rate of reduction in US Treasury bonds, and the size of US debt maturing each month will decrease.

Currently, Wall Street strategists expect that the Federal Reserve will lower the upper limit of the monthly reduction scale of US Treasury bonds from 60 billion US dollars to 30 billion US dollars, while keeping the MBS reduction limit unchanged.

According to the minutes of last month's meeting, most Federal Reserve participants pointed out that although the Federal Reserve's balance sheet has been drastically reduced, reserve balances have remained at a high level because the decline in the use of overnight reverse repurchase agreement (ON RRP) instruments has turned the Fed's liabilities into reserves. And as the decline in the adoption rate of ON RRP becomes more limited in the future, further downsizing may more directly translate into a decline in reserve balances, which may fall rapidly. Since it is uncertain what reserves operate at the same level as an adequate reserve mechanism, slowing down the contraction sooner rather than later will help facilitate a smooth transition from abundant to sufficient reserve balances.

Currently, the Federal Reserve's bank reserves are around $3.6 trillion. Federal Reserve Chairman Powell said at a press conference after the monetary policy meeting last month that the adequate level of preparation is “slightly lower” than the current level.

The Goldman Sachs report in November last year indicated that when bank reserves change from abundant to sufficient, that is, when changes in reserve supply have a real but moderate impact on short-term interest rates, the Federal Reserve may stop downsizing. At the time, Goldman Sachs estimated through model estimates that short-term interest rates will begin to become more sensitive to changes in reserves around the third quarter of this year. It is expected that at that time, the Federal Reserve will begin to slow down the contraction, cut the maximum monthly reduction limit for treasury bonds and MBS in half in the fourth quarter, and the contraction will end in the first quarter of the year.

At the same time, Goldman Sachs pointed out that the key risk is that the increase in US debt issuance this year may cause problems in the US treasury bond market. In order to avoid fluctuations in the money market, the Federal Reserve may stop downsizing early.

edit/lambor