Fed balance sheet draw down going well

© Reuters. People walk by the Federal Reserve Bank of New York in the financial district of New York City, U.S., June 14, 2023. REUTERS/Shannon Stapleton/File Photo

By Michael S. Derby

NEW YORK (Reuters) – A top Federal Reserve Bank of New York staffer said Wednesday efforts to shrink the size of the central bank’s balance are proceeding smoothly and officials are closely watching for market signals that it’s time to stop the draw down.

“Balance sheet reduction has been proceeding as planned and reserve supply remains above ample,” which signal markets are still enjoying plenty of liquidity, said Jule Remache, Deputy System Open Market Account manager and head of Market and Portfolio Analysis for the bank, in a speech text prepared for the Women in Fixed Income Conference in New York. The head of the System Open Market Account, who is responsible for implementing Fed monetary policy directions, is Roberto Perli.

Remache was discussing the outlook for the Fed’s work to trim the size of its holdings, which more than doubled to a peak of $9 trillion by the summer of 2022 due to central bank bond buying aimed at stabilizing markets and providing stimulus to the economy. The Fed has thus far shed about $1.4 trillion from its holdings, and with the central bank nearing its first rate cut, markets are actively debating when balance sheet draw down will also stop.

Remache acknowledged a wide range of market views on that question and did not offer her own forecast. But she said in her speech that money market conditions are showing “incremental signs” of shifting in response to tighter liquidity conditions. She pointed to more volatility in short-term rates, although she noted that did not extend to the federal funds rate, the central bank’s chief tool to influence the economy.

“In the coming months, we will be monitoring money markets for emerging pressures, which may at some point indicate we’re getting closer to a level that is somewhat above ample,” the Fed official said

Remache pointed to the draw down in the size of the Fed’s reverse repo facility as evidence of the Fed’s withdrawal of liquidity. That facility has fallen from a peak of $2.6 trillion at the end of 2022 to $553 billion on Wednesday. Many see the reverse repo tool as a proxy for excessive liquidity and believe when it is near zero or close to it, the Fed will have to actively weigh stopping its balance sheet draw down.

Remache said she expects further drops in the reverse repo facility and that bank reserve levels, which have been fairly steady, will also begin to shrink.

But Remache also cautioned that various factors in the financial system argue against the Fed returning its holdings to their pre-pandemic $4.2 trillion size. The Fed’s current balance sheet size is $7.7 trillion.

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