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Since the pandemic began, the nation’s central bank has aggressively printed trillions of dollars to keep the U.S. economy afloat. Doing so has ballooned the Federal Reserve’s balance sheet to nearly $9 trillion.
Fed officials, acknowledging the rising risks posed by inflationary pressures, are now starting to think about whether or not they can move to shrink the central bank’s holdings next year.
“I have no idea what a normal balance sheet looks like anymore,” said Federal Reserve Governor Christopher Waller on Dec. 17.
Since the depths of the pandemic, the Fed has been buying U.S. Treasuries and agency mortgage-backed securities in the open market. Those purchases, in a process often referred to as “quantitative easing,” serve as a signal to markets that the Fed is serious about its intention to keep financing conditions loose.
In November, the Fed kicked off the process in slowing the pace of those purchases, which it had been running at a clip of about $120 billion per month. After a print on inflation showing the fastest pace of price increases since 1982, the Fed moved on Dec. 15 to more quickly draw down its purchases.
When the Fed brings the quantitative easing program to a full stop around March, policymakers will then turn their eyes to raising interest rates (from the current setting of near zero) — and perhaps an unwinding of its balance sheet. The Fed signaled the likelihood of three interest rate hikes next year, a more aggressive path than Fed watchers had originally expected.
“In light of this slightly earlier timing of hikes and Powell’s comment that differences with the economic situation last cycle could influence thinking about balance sheet policy,” wrote Goldman Sachs Economics in a note.
Wall Street analysts are pulling forward their expectations for when the Fed would start “quantitative tightening,” the process of shrinking the balance sheet by allowing maturing securities to “rolloff” (as opposed to reinvest in new securities).
Deutsche Bank, which originally expected the Fed to start the balance sheet unwind in the third quarter of 2023, now expects that process to begin in the “back half of next year.” Goldman Sachs had originally forecast a start date in the first half of 2023, but now expects quantitative tightening to begin in the fourth quarter of next year.
What has the Fed said?
Fed Chairman Jerome Powell punted on the question of balance sheet strategies when he was asked about it following the Fed’s most recent policy-setting meeting.
“Didn’t make any decisions today,” said Powell on Dec. 15, adding that the Fed will deliberate on the timing of any balance sheet runoff in coming meetings.