Bloomberg News reports that the Federal Reserve is starting to shrink its $8.9 trillion balance sheet, thereby deploying its second tool aside from higher interest rates to curtail inflation. However, the officials do not know how effective the move will be.
After making the size employing asset purchases in the first two years of the pandemic, there will be a reduction in the balance sheet at a pace almost twice as fast as the previous financial crisis. The process commences on Wednesday officially. The first US Treasury securities will not run off till the $15 billion maturities on June 15th.
Fed’s maturities in June
Four Treasury securities totaling $48.25 billion held by the Fed are maturing in June, leaving $18.25 billion over the $30 billion runoff cap that is to go for reinvestment.
| Maturity date | Par value ($ billion) |
| 15th June 2022 | 14.9 |
| 30th June 2022 | 13.3 |
| 30th June 2022 | 15.4 |
| 30th June 2022 | 4.6 |
Source: New York Fed
There is a capping of the monthly runoff by the Fed at $47.5 billion- $30 billion for the Treasuries and $17.5 for the securities that are mortgage-backed until September. These thresholds will then become twice a combined $95 billion. This compares to a peak amount of $50 billion per month when the Fed initiated the exercise commencing in 2017.
Bloomberg News reports that as per officials, the reduction will be in sync with the increase in interest rate to cool the pressure of the prices by tightening the financial conditions. But it is still not clear how much the balance sheet will impact, as Fed Governor Christopher Waller stated in his Monday speech about estimates related to using different assumptions and highly uncertain models.
There was a massive deployment of asset purchases at the time of the 2008 financial crisis for the first time since the World War 2 took place, thereby the balance sheet getting expanded to approximately $4.5 trillion by the time the financial crisis came to an end, which was towards the latter part of 2014. It then waited three years before it could allow it to shrink at 2017 end, reducing it to approximately $3.8 trillion by September 2019.
Uncertainty related to the course of the balance sheet was revealed by commentators that might have contributed to the market turbulence that eventually helped bring an end to the last rate hike campaign of the Fed, which ended in December 2018. The Fed is increasing the benchmark rate at a fast rate, intending to tighten the financial conditions and combat inflation, which has reached the last four decades at the highest levels in recent months.
