Federal Reserve officials are close to deciding whether to cut the number of government bonds on its balance sheet. Certainly, both markets and investors are watching this event so they can understand how far the board will be willing to go to reduce its monetary policy.
The Fed’s budget reached more than $4.5 trillion in October 2017. Market experts are beginning to worry that this will add more pressure to the market after a series of interest rate hikes initiated by the Fed which began in 2015.
The policy-making body has been considering reducing the balance sheet during its recent meetings, with officials pointing out last December that the Federal Reserve’s benchmark funds rate could become volatile. This is likely to set the end date of the FOMC meeting next week.
“We’re waiting for the committee to be satisfied that they have reached sufficient understanding of what all the moving pieces are.” said Esther George, the Kansas City Fed President on Jan. 15.
The Federal Reserve cut its balance sheet by allowing a certain level of bond yields to be made each month, while the rest was reinvested. The maximum roll-off was $50 billion per month. December also saw a $34 billion decline in treasury bonds and mortgage-backed securities in the program.
The main concern of the market and its participants is always about the level of reserves the banking system are comfortable having. Thus, a high level of reserves in the system corresponds to a higher budget, which means that the Federal Reserve may limit the roll-off earlier than expected.
While Federal Reserve officials believe that a reduction in the public budget can be done with minimal market damage, this has never been the case. Stocks opened higher on Friday, although it was not clear whether the general trend was influenced by the policy of the board or not. Markets reacted negatively at different points on budget news, especially with large selloffs in December after Federal Reserve Chairman Jerome Powell said the process was going smoothly and was unlikely to change.
However, according to market analysts, the Fed had to abandon its position on the public budget after a negative reaction in the market in December, and it is still not convinced of the theories of quantitative tightening that will cause a significant financial tightening. With the problem expected to be resolved between March and June, the final size is expected to reach about $3.5 trillion, or $600 billion below the current level.
It should be noted here that the balance sheet was expanded during three rounds of bond purchases that began during the financial crisis and continued as the economy continued to expand at a slow pace. The purchases eventually ended in October 2016 and the roll-off process began one year later.