The Federal Reserve has now offloaded about $1 trillion of its bond holdings since it began working down its bloated balance sheet last year, with no sign of the kinds of strains in financial markets that spooked policymakers the last time they oversaw such a program.
The System Open Market Account — the name for the central bank’s portfolio of assets — amounts to about $7.4 trillion now, down from the record $8.4 trillion reached in April last year, data from the New York Fed show. As part of its steepest monetary-tightening campaign in decades, the Fed is letting up to $60 billion of Treasuries and $35 billion of mortgage-backed debt mature each month without replacement.
Those shrinking holdings force the Treasury Department to rely more heavily on the private sector to take up federal debt. And so far, money-market funds and other buyers have been happy to snap up the slew of Treasury bills Washington has been offering as a key part of its ramped-up funding requirement. The issuance was made all the bigger by the need to replenish cash after the debt-limit fight.
“The Fed’s debt runoff so far has been fairly painless,” said Blake Gwinn, head of US interest-rate strategy at RBC Capital Markets. “We just haven’t seen a big impact of QT in the marketplace,” he said, referring to quantitative tightening, the term for the Fed’s balance-sheet contraction.
That compares with 2019, when U.S. money markets were roiled during the Fed’s first go-round with QT. That time, the program ended up draining bank reserves, causing a scarcity that Chair Jerome Powell admitted in a June congressional hearing had blindsided policymakers.
Gwinn highlighted that, so far this time, reserves are largely unchanged in recent months. Instead, QT has taken more of a bite out of a facility where money-market funds park some of their cash — the Fed’s reverse repurchase program, known as the RRP. That account is now about $1.6 trillion — or roughly half the amount of bank reserves — after reaching a high of about $2.6 trillion in December.
As the Fed’s QT keeps going, it will potentially eat more into reserves, imposing more of a test on markets. Another key dynamic is what the Treasury decides to sell as it copes with its expanding funding requirement, propelled also by a widening fiscal deficit. High-yielding T-bills have been in strong demand lately, but the Treasury is also lifting is sales of longer-dated securities, in a shift that’s drawing attention to Washington’s debt trajectory.
The Treasury already in August began to lift the sizes of its note and bond auctions for the first time in more than two years. Gwinn forecasts a similar move in November and another, though slightly smaller one, in February.
“How Treasury tries to offset the loss of the Fed is also a major component of measuring how QT is impacting markets,” he said.