Wall Street’s leading financial institutions have revised their forecast on when the Federal Reserve’s endeavor to reduce its balance sheet will conclude. Meeting minutes from the Fed’s recent policy gathering reveal this shift, following input from banks prior to December’s discussion.
Initially expected by May, banks now anticipate the conclusion of the balance sheet reduction process, referred to as quantitative tightening (QT), by June this year.
The Federal Open Market Committee meeting held on December 17-18 resulted in a quarter percentage point cut to the interest rate target range, now between 4.25% and 4.5%. It also adjusted future rate cut expectations and projected a higher inflation trajectory. Despite these updates, the Fed did not introduce new measures concerning its QT efforts but adjusted the reverse repo facility rate to incentivize shifts of funds into private markets.
After a surge in bond acquisitions during the pandemic, the Fed’s goal has been to reduce its holdings and consequently, the market’s excess liquidity. This move has decreased holdings from a peak of $9 trillion to just under $7 trillion, targeting a restored volatility threshold and firm grasp on the federal funds target rate range.
Previously, major banks informed the New York Fed that they foresaw QT concluding by May, with total holdings near $6.375 trillion. This contrasts with current reserves located at approximately $2.9 trillion.
The Fed faces a complex challenge: avoiding excessive liquidity withdrawal that might trigger market instability. Complicating the outlook are uncertainties tied to government financing needs as Donald Trump resumes the presidency, coupled with disruptions in the private repo market that spurred significant volatility last September.
The minutes emphasize several 2024 factors that could impact the Fed’s balance sheet trajectory, notably a potential government debt limit return that may confound liquidity assessments and influence reverse repo facility activities.
