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The Fed: Fed lays out tentative plan to shrink balance sheet by $95 billion a month

The Federal Reserve on Wednesday laid out a long-awaited, tentative plan to shrink its balance sheet by roughly $95 billion per month.

In the minutes of its March meeting, officials stressed that no final decisions had been made.

Officials said that they’ve made enough progress to start the winddown of its $8.5 trillion portfolio as soon as May.

“It would certainly be surprising if they do not” start the winddown in May, he said.

The Fed said that after a phase-in of three months or longer, it could settle on a plan reduce its bondholdings by allowing about $95 billion to roll off monthly without reinvestment, beginning with about $60 billion in Treasurys and $35 billion in mortgage bonds.

“No decision regarding the Committee’s plan to reduce the Federal Reserve’s balance sheet was made at this meeting, but participants agreed they had made substantial progress on the plan and that the Committee was well placed to begin the process of reducing the size of the balance sheet as early as after the conclusion of its upcoming meeting in May,” according to the minutes.

Kaleb Nygaard, senior research associate at Yale University’s program on financial stability, said the Fed has clearly signaled it will start the wind down in May, along with a 50 basis point interest rate hike.

“The assumption is we are on track for the beginning of the decrease in the balance sheet and a 50 basis point hike,” he said.

Read: Fed primed to jack up interest rates in 50 basis point steps

The Fed’s balance sheet doubled over the pandemic from $4.5 trillion as the central bank rushed to the rescue of the Treasury market and the economy.

A large Fed balance sheet stimulates demand and the Fed wants to shrink it given that inflation is running at 40-year highs.

The Fed does not have much experience winding down its balance sheet. It only has done it once before – from 2017 until 2019 when it allowed about $700 billion to runoff.

This time, economists think the Fed would like to reduce the balance sheet by roughly $1 trillion for three years, until the balance sheet is closer to $6 trillion.

The last episode of balance sheet reduction ended abruptly in September 2019 when tremors in money markets forced the Fed to start buying securities again.

The minutes said that officials would be more cautious this time when it gets close to its goal.

In addition, the Fed has set up a tool to provide funding to money markets.

Unlike 2017, the Fed now has T-bills on its balance sheet.

The minutes show that “most” officials judged that it would be appropriate to redeem Treasury bills in months when Treasury coupon principal payments were below the caps that have been set out.

The yield on the 10-year Treasury note TMUBMUSD10Y, 2.613% have risen sharply in recent days as investors have come to view the Fed as increasingly hawkish.

Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, said the Fed’s balance sheet could decline to $5.06 trillion from $8.48 trillion if the full program runs for three years.

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