NEW YORK: The Federal Reserve (Fed) on Wednesday said it will start culling assets from its US$9 trillion (RM39 trillion) balance sheet in June and will do so at nearly twice the pace it did in its previous “quantitative tightening (QT)” exercise, as it confronts inflation running at a four-decade high.
The central bank’s stash of assets has roughly doubled in size during the coronavirus pandemic as it used purchases of Treasuries and mortgage-backed securities to smooth market functioning and augment the effects of its interest rates cuts.
Now it wants to reverse much of that, and in relatively short order, alongside rate hikes meant to cool inflation. Here’s a rundown of what is in the cards now and how it differs from the 2017-2019 “QT” period.
The Fed’s announcement of the start of this QT round came just one meeting after lifting its benchmark short-term interest rate for the first time since 2018.
In the previous episode, the launch of QT in the fall of 2017 occurred nearly two years after that cycle’s first rate hike, which had taken place in December 2015.
This time’s onset of QT is also a bit earlier relative to where the Fed is in its overall tightening process. Along with announcing that QT will start on June 1, the Fed on Wednesday lifted its target rate to 0.75% to 1%. Last time, QT did not begin until rates had reached 1% to 1.25%.
Come September, the Fed will be cutting US$95bil (RM412.1bil) a month from its holdings, split between US$60bil (RM260.3bil) of Treasuries and US$35bil (RM152bil) of mortgage-backed securities (MBS).
That is roughly double the maximum pace of US$50bil (RM217bil) a month targeted in the 2017-2019 cycle. Back then, the split was US$30bil (RM130bil) of Treasuries and US$20bil (RM87bil) of MBS.
In the last cycle, it took a full year for the Fed to reach that maximum reduction rate of US$50bil (RM217bil) a month. It started with US$10bil (RM43.4bil) a month (US$6bil or RM26bil Treasuries and US$4bil or RM17.4bil MBS) and increased that by US$10bil (RM43.4bil) a quarter until it reached its maximum rate in the fall of 2018.
This time, it will go from zero to US$95bil (RM412.1bil) in the space of three months, with only one initial step before moving to the maximum reduction pace.
On June 1, it will start the process at US$47.5bil (RM206bil) a month for the first three months, divided as US$30bil (RM130bil) of Treasuries and US$17.5bil (RM76bil) of MBS. It will increase to the full US$95bil (RM412.1bil) three months later.
When the Fed kicked off its first-ever QT undertaking, its total balance sheet was around US$4.5 trillion (RM19.5 trillion) in size. In nearly two years of QT, it managed to bring that down by about US$650bil (RM2.82 trillion) to a bit over US$3.8 trillion (RM16.5 trillion) before it brought the programme to a stop.
This time, the annualised monthly rate of reduction works out to more than US$1.1 trillion (RM4.77 trillion) a year in balance sheet roll-offs once it attains its maximum pace.
That means it will likely surpass the total of the entire 2017-2019 QT cycle by early 2023. Many economists see officials targeting about US$3 trillion (RM13 trillion) in total balance sheet shrinkage over a three-year span.
The Fed’s Treasuries portfolio is shorter in maturity this time than in the previous QT round by about two years, according to New York Fed data. That is in part owing to the substantial purchases of T-bills, particularly early on in the crisis, to help restore market stability.
The Fed said it would slow and then stop the QT process when banking system reserve balances are “somewhat above the level it judges to be consistent with ample reserves.”
The Fed relies on a system of “ample reserves” to conduct its policy, and QT will reduce that pool of funds, which are deposited by banks with the Fed. — Reuters