When will the Fed put an end to reducing its balance sheet? 

During the pandemic, the Fed reduced its interest rate target to near zero and bought approximately $4.8 trillion in Treasuries and mortgage-backed securities to invigorate the economy and keep longer-term interest rates low. The excess liquidity created from this process resulted in rapidly increasing reserves and balances in reverse repo agreements.

In response to inflation standing well above its long-run target, the U.S. central bank began unwinding its accommodative monetary policy in Q2 2022. In practical terms, it stopped reinvesting in maturing Treasuries and MBS, passively shrinking its assets as those securities expired without being replaced. From April 2022 to January 2024, the size of its balance sheet has been reduced from $8.97 trillion to $7.68 trillion.

With a $35 billion reduction from December 27 to January 24 alone, it’s clear that the quantitative tightening policy is not over even if Powell indicated a minimum of three rate cuts in 2024. Unfortunately, he did not provide further details about the policy pursued by the Federal Reserve on the size of its balance sheet.

Beyond the expected rate cut starting from May, the key question market players are likely to ask is: when the Fed will stop its quantitative tightening? Or said differently, how far can it shrink its balance sheet without causing dislocations in places like the repurchase-agreement market or derailing its broader policy goals?

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.