Source: Golden Ten Data

Some economists say the Federal Reserve may announce a slowdown in balance sheet reduction (quantitative austerity, QT) as early as this week's policy meeting. However, due to the uncertain interest rate outlook due to high inflation, the release of the statement may also be postponed until June.

Under the current QT plan, the Federal Reserve allows up to $95 billion of US Treasury bonds and mortgage-backed securities (MBS) to expire each month. Federal Reserve officials have been hinting that they will soon slow down the pace of QT, and have indicated that by slowing the pace of QT, they can reduce the risk of market liquidity collapse while also reducing their bond holdings to a greater extent.

The Federal Reserve doubled its balance sheet to $9 trillion after the COVID-19 outbreak to stimulate the economy, but as inflation soared, the Federal Reserve raised interest rates sharply and launched a QT plan at the same time.

Currently, the Federal Reserve's bond holdings have dropped to around 7.5 trillion US dollars. Although it is not clear what level of holdings it wants to reach, the Federal Reserve is seeking to maintain market liquidity at a certain level. According to a recent report released by the New York Federal Reserve, the QT program is likely to continue until 2025, after which the Federal Reserve's bond holdings will stabilize.

The minutes of the March meeting of the Federal Reserve show that officials tend to reduce the size of QT. Their focus is only on slowing the reduction of US Treasury bonds, because MBS's reduction is far below the maximum limit of 35 billion US dollars per month, and in the end, they only tend to hold US Treasury bonds.

Economists at J.P. Morgan Chase said in a research report: “The next step in the Federal Reserve's QT plan is very clear, which is to reduce the maximum monthly treasury debt reduction limit from 60 billion US dollars to 30 billion US dollars. The only real question is when, will it be at the May meeting or the June meeting.”

They said, “We prefer the (May) meeting” because interest rate policies for this meeting are not expected to change, and there are no updates to the economic summary forecast.

The Federal Reserve has spared no effort to separate its QT plan from its interest rate policy, although both are working in the same direction to make the Fed's policy more strict overall.

ICAP analysts at Wrightson believe that the Federal Reserve will announce a reduction in the QT scale at the end of the two-day policy meeting in the early hours of Thursday morning Beijing time because “there is no obvious reason to wait.”

Bank of America economists also believe that the Federal Reserve will announce a slowdown in QT this week because it will help it manage liquidity needs generated by banks and the Treasury to manage cash flow.

Others, however, think the issue will have to be delayed for a month.

A Deutsche Bank economist said, “We now expect the announcement to lower the cap on US Treasury debt reduction will be postponed until the June meeting. Although officials seem to generally agree on the parameters of this adjustment, we doubt they may want to avoid any dovish misunderstandings due to the slowdown in QT, as this may inadvertently ease the financial situation.”

Given that the Federal Reserve will announce a new round of interest rate decisions and economic summary forecasts at the June meeting, the bank said, “It is best to combine this statement with the more hawkish signals on the June meeting” to avoid mixed policy information.

LH Meyer's analysts are also inclined that the Federal Reserve will announce a slowdown in QT in June, and pointed out that “the Federal Open Market Committee (FOMC) can decide on the general framework ('principles and plan') and announce it after the May meeting so that the market can confirm what the whole process will look like, but there is no need to prejudge when this step will be taken.”

edit/lambor