Fed to abruptly end balance sheet reduction in September unlikely: Citi By Investing.com

The Federal Reserve is unlikely to suddenly announce a balance sheet reduction that ends in September or sooner, Citi economists said in a note on Wednesday.

The Wall Street bank has previously argued that the Federal Reserve is likely to stop tapering before reserves reach “somewhat above” ample levels, especially in the event of a recession.

Last year, during the July 2023 press conference, Fed Chairman Powell mentioned that in a world where things are fine and the Fed is just normalizing lower rates, the balance sheet reduction could continue even as policy rates fall.

However, that narrative could change “if there is a material weakening of the labor market and activity,” Citi economists note.

With the latest jobs report revealing more slack in the labor market than most economists and the Fed anticipated, it has become more likely that policymakers will signal at the September meeting that the end of balance sheet reduction is near, potentially by in December.

“If data on activity and the labor market deteriorates further in the coming weeks, an earlier end to the balance sheet could be signaled at the September meeting, but a sharp end in September would not be our base case unless acute liquidity problems”, continued the economists.

“We do not expect major liquidity pressures in the coming months, with reserves still at ample levels, reverse repo balances still at ~$290 billion and the standing repo facility serving as support.”

In the week ended July 31, the Fed’s balance sheet shrank by about $27 billion, with $10 billion in Treasuries and $14 billion in mortgage-backed securities.

On the liabilities side, the Treasury Cash Account (TGA) rose to $854 billion on July 31 due to month-end settlements, but has since fallen to $759 billion. The Treasury has indicated that TGA will reach about $850 billion by the end of September, falling to $700 billion by the end of the year once the debt limit suspension ends.

Reverse repo balances (RRPs) remained more persistent than expected despite the increase in SOFR rates, likely due to intermediation and counterparty limit issues. Because of this and strong TGA liquidity, bank reserves fell to $3.178 trillion from $3.276 trillion in the same week.