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Fed's Balance Sheet Reduction: A Predicted Slowdown
The internal deliberations of The Federal Reserve concerning the future of its balance sheet reduction initiative are expected to intensify this March, during its policy discussions. Policymakers are likely to initially strategize on the slow drawdown, postponing the absolute termination of the process to a future date.
Reflections From Past Meetings
The minutes of the Federal Open Market Committee (FOMC) meeting, held on January 30-31 and released this Wednesday, have revealed a keen interest among "many participants" to initiate "comprehensive discussions" during the upcoming March 19-20 meeting. They are planning to conclude the consistent decrease in bond holdings by the Fed.
Finding Solutions Amidst Uncertain Elements
Key officials noticed the continuous drain of cash from a crucial central bank instrument termed as the overnight reverse repo facility, which acts as a mirror for surplus liquidity in the financial sector. They believe that they are close to the time when they will have to manage an endgame strategy to maintain tranquility in the financial markets. The main focus of the debate will be on how to eventually slow down the process popularly known as quantitative tightening, or QT, at the forthcoming FOMC meeting in March.
QT Accompanying Fed Rate Hikes
Since the FOMC has undertaken to double the size of its holdings to nearly $9 trillion by the summer of 2022, the task of reducing the current balance sheet (of $7.7 trillion) by changing QT's pace has become more significant. In order to control price pressures that are about to revert to the target of 2%, the Fed officials are openly debating whether they can lower the federal funds target rate from its current 5.25%-5.5% range.
Conclusion
To avoid past mistakes and prevent market disruptions, the Federal Reserve will likely start the QT process with a careful tapering strategy. While there’s no definite endpoint in sight, this gradual approach allows the tapering process to continue for a longer duration.
