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Fed’s balance sheet: plus $ 5tn
MARKET INSIGHTS
October 15th, 2021
This is roughly the amount that the portfolio of securities held by the Fed will have increased when the asset purchase programme draws to a close around mid-2022. The Fed holds approximately one-quarter of the outstanding federal debt (15% before the pandemic), which acts as a drag on long-term rates. There is an excess of liquidity in the money market, as evidenced by the massive use of the reverse repo facility. Even so, the central bank is not actively reducing its imprint in the bond market. Its priority at this time is to exit an emergency measure and to signal, as inexpensively as possible, its vigilance on the inflation risk.
The week’s focus
Even before it is made official next month, the Fed's tapering of asset purchases is accepted by all. The progress made by the US economy since December 2020 is considered sufficient to make the leap. There was no panic like in 2014. Jerome Powell made the preparation for the tapering a non-event. The process will be spread over eight months if, as seems to be the preferred option, the pace of purchases is reduced by $ 15bn per month. By June 2022, the Fed’s balance sheet will be close to $ 9,000bn, or the equivalent of 38% of GDP. In the previous tapering in 2015, the peak was 26% of GDP. In short, since the start of the pandemic, the Fed's balance sheet will have been inflated by nearly $5tn (chart lhs). On the assets side, the increase is due to the securities portfolio. During the acute phase of the crisis, the Fed also increased its lending and swap facilities, but these items are now normalised. On the liabilities side, there has been an increase in bank deposits and, in recent months, a surge in the Reverse Repo. This shows that the interbank market is brimming with liquidity. There's no need to add more.
What does the Fed weigh on the bond market? It holds approximately 25% of total outstandings of federal securities and MBS. Its share of Treasuries’ holdings was higher in the 1970s, but this was not the result of an active policy to support the markets but rather a passive adjustment to changes in fiscal policy (chart rhs). QE is now part of the monetary toolkit. In the future, it could take different forms as needed. In a recent paper, Fed economists suggested that QE be modulated (fixed amount, open programme with adjustable flows, specific targeting to support a given agent) according to the types of shocks suffered by the economy. At the current programme’s close, the Fed will not withdraw from the market, selling no securities, and reinvesting maturing ones. Paper absorption requirements will be reduced with the cyclical reduction in the federal deficit. In any case, the Fed is likely to keep some pressure on long-term rates. Maintaining a large portfolio of securities is supposed to weigh on their absolute level.
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