The Fed is preparing to trim the size of the swollen balance sheet by $95 billion a month

The Federal Reserve will begin shedding $95 billion in assets each month from its swollen $9 trillion balance sheet as it ramps up efforts to curb rising U.S. inflation.

A report from the Federal Open Market Committee’s last meeting in March showed that officials were finalizing a plan to reduce the central bank’s presence in US Treasury markets.

The central bank’s presence in debt markets has expanded significantly during the pandemic, as it soaked up trillions of dollars in government bonds and mortgage-backed securities from agencies to stave off economic disaster.

But faced with sustained high inflationThe Fed is attempting to tighten monetary policy, and reducing its balance sheet is the most important lever it can pull to cool the economy after rate hikes.

According to the March meeting minutes, officials are broadly supportive of the Fed increasing the pace at which it is reducing its asset holdings in the coming months through a process known as “run-off,” in which central banks are required to reinvest the proceeds from maturing stop securities.

FOMC members broadly agreed on monthly caps of about $60 billion for Treasuries and $35 billion for Agency MBS, to be phased in over a period of three months or “modestly longer when market conditions warrant”. That means nearly $1 trillion in wealth depletion per year.

The minutes show that central bankers are looking to shrink the balance sheet quickly, much faster than the previous attempt to unwind assets in 2017, after the Fed’s holdings soared on bond purchases amid the global financial crisis that began in 2008 was.

Back then, the Fed capped monthly balance sheet reductions at $50 billion and took a year to hit that pace.

Lael Brainard, a governor awaiting confirmation from the Senate to become the Fed’s next vice chair, said Tuesday the cut would “fast‘ and could begin as early as his next political meeting in May.

She said a quick response was warranted given the extent to which inflation exceeded the central bank’s 2 percent target strength of the labor market.

Fed Chairman Jay Powell has previously indicated that the expected pace of balance sheet deleveraging this year is roughly equivalent to a quarter-point rate hike.

Line chart of assets held by the Federal Reserve, $trillions, showing Fed planning

Minutes from the March meeting also showed that officials were more open to more aggressive rate hikes this year to combat rising prices after deciding to hike the federal funds rate by a quarter percentage point for the first time since 2018.

That could include raising the federal funds rate in half-point increments to bring it to a “neutral” level that will neither accelerate nor slow growth this year. Officials put that rate at 2.3 to 2.5 percent.

In the weeks since the meeting, where a majority of officials signaled that the key interest rate should rise to 1.9 percent by 2022, policymakers have done so supposed an even more hawkish attitude.

Mary Daly, President of the San Francisco Fed, told the Financial Times on Friday said arguments for a half-point rate hike had grown at the May meeting, echoing a number of their peers who had signaled support for faster and more vigorous monetary tightening in recent weeks. The Fed is preparing to trim the size of the swollen balance sheet by $95 billion a month

Adam Bradshaw

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