Fed’s Powell says balance sheet shrinking continues amid rate cuts Reuters

By Michael S. Derby and David Lawder

NEW YORK (Reuters) – Federal Reserve Chairman Jerome Powell said on Wednesday that still strong levels of liquidity in the financial system will allow the central bank to continue reducing its balance sheet even as it has started to cut interest rates.

“Reserves are still plentiful and expected to remain so for some time,” Powell told a news conference following a monetary policy meeting in which the central bank kicked off a rate-cutting cycle with relatively large easing of half a percentage point, against higher expectations. rate cuts loom as inflation falls.

Powell addressed the process of what is called quantitative easing or QT. This requires the Fed to withdraw the liquidity it added by buying bonds during the pandemic, a process that has so far reduced total holdings from a peak of $9 trillion in the summer of 2022 to the current value of 7, 2 trillion dollars.

The drawdown, which the Fed slowed earlier this year, currently involves allowing up to $60 billion a month to expire and not be replaced in Treasuries and mortgage bonds. The QT process began amid the Fed’s aggressive rate hikes aimed at reducing inflationary pressures.

Fed officials have repeatedly said that they view QT as a background process and that interest rate changes are their primary tool to affect the economy. QT differs from quantitative easing or bond buying because this process generally takes place against the backdrop of unstable markets and aims to strengthen the potency of monetary policy when rates are close to zero.

Some analysts have speculated that if the Fed were to pursue a half-percentage-point rate cut, it could accelerate the end of QT to better align the scope of the Fed’s toolkit. In doing so, it would avoid the complicated optics of easing rate policy, even as its balance sheet policy technically tightens financial conditions, allowing long-term yields to rise.

In the news conference, Powell noted that most of the drawdown left the bank reserve parked at the Fed largely untouched and instead pulled cash out of the reverse repo facility. Reserves stood just above the $3 trillion mark as of June 2022.

Meanwhile, reverse repo inflows pushed money funds from parking more than $2 trillion a day to work unit to $305.8 billion on Wednesday.

The reverse repo facility has long been seen as a vehicle to hold excess liquidity, so Fed officials have been waiting for its withdrawal. When reserves begin to fall, it more directly affects Fed policy, it aims to have enough liquidity in the financial system to give it firm control over the interest rate target while allowing for normal market volatility.

Powell, in the press conference, pointed to the reverse repo facility and said what’s happening there shows that “we’re not thinking about stopping the drain,” even as the federal funds rate falls.

A survey of market participants by the Fed in July predicted a spring stopping point for QT. Fed officials have repeatedly said they are not sure when the bottom line will come into play and will watch for signs in the market about whether liquidity is tightening too much.