Fed Steps Up Deliberations on Shrinking Its $9 Trillion Asset Portfolio

Allowing the asset purchases to end in March “seems like the right sequence,” New York Fed President

John Williams

told reporters Jan. 14. “From my point of view, the asset purchase program is essentially already coming to an end.”

The Fed’s asset portfolio, sometimes referred to as its balance sheet, has more than doubled since March 2020. The Fed bought nearly $1.5 trillion in Treasurys in March and April 2020 to prevent turmoil in the market for U.S. government debt from igniting a broader financial meltdown, when the coronavirus pandemic triggered a dash for dollars.

The Fed continued to buy at least $120 billion a month in Treasury and mortgage-backed securities after that to provide additional support to the economy. Officials began to reduce those monthly purchases in November.

After the Fed completed a similar round of bond-buying stimulus in 2014, it kept its holdings steady by reinvesting the proceeds of maturing securities into new ones for more than 2½ years before slowly and gradually allowing more securities to mature without any reinvestments, shrinking the balance sheet.

Fed Chairman

Jerome Powell

and several colleagues have indicated such a turn from expanding the portfolio to contracting it is likely to be measured in months and not years this time around.

“The economy is in a completely different place than it was when we ended asset purchases the last time,” Mr. Powell said at a congressional hearing earlier this month, referring to the current mix of high inflation and rapidly declining unemployment.

He also said the Fed could allow its holdings to shrink more quickly than it did between 2017 and 2019, when they fell to around $3.7 trillion from $4.5 trillion, in part because they are so much larger now.

In a recent interview, Cleveland Fed President

Loretta Mester

said she would prefer “to move the balance sheet down as fast as feasible.” She added that recent studies “so far suggest we can go considerably faster than we did last time without causing disruption.”

Officials began their deliberations last month, and it is possible they could on Wednesday release high-level principles for how any runoff would proceed, as they did when they neared the conclusion of their asset purchases in 2014.

But they are unlikely to release more meaningful details on how the reduction would proceed, such as the amount of bonds that might be allowed to roll off the Fed’s balance sheet in any month. Mr. Powell has said that it could take another two or three meetings to firm up such plans, suggesting that the process is likely to start no sooner than the middle of the year.

“I find that the best ideas sometimes take a while to surface,” he said. “They did the last time on this issue.”

Fed officials must resolve a series of technical questions, including which securities should be purchased with the proceeds of maturing ones and whether to consider active sales of mortgage-backed securities.

Former Fed Chairman

Ben Bernanke

often argued that the maturity and risk profile—not the size—of the securities holdings determined the degree to which bond purchases stimulated the economy. Under such thinking, purchasing longer-dated assets provided more stimulus.

Fed governor

Christopher Waller

last month said when the Fed stops increasing its overall holdings, he would prefer that the central bank purchase short-term Treasurys when and if it reinvests the proceeds of any maturing mortgage-backed securities. Doing so would further weight the Fed’s holdings toward shorter-dated assets that provide less stimulus.

Several Fed officials, including Mr. Powell, have indicated that they want adjustments of the Fed’s short-term benchmark interest rate, the federal-funds rate, to be the primary way that the central bank responds to changes in the economic outlook. This means they are likely to again prefer a path for unwinding their asset holdings that runs on a premapped schedule once they have raised rates somewhat.

“If it worked last time, the threshold to do something different is pretty high,” said

William Dudley,

who was New York Fed president from 2009 to 2018. “The way they want it to work is once they set the balance sheet tool in motion, they don’t have to change it. The federal-funds rate is the active tool.”

Officials have long said that it is easier for them to communicate their policy moves by raising or lowering interest rates rather than by changing the speed at which the portfolio grows or shrinks.

That is the case in part because there is little consensus within financial and central-banking circles over how changes in the Fed’s bondholdings influence economic conditions. Economists at

Deutsche Bank

estimate that if the Fed were to reduce its holdings by around $1.5 trillion between this summer and the end of next year, it could have the effect of around three quarter-percentage-point rate increases.

Write to Nick Timiraos at [email protected]