Balance Sheet Normalization is Under Way

Since the end of the latest quantitative easing program in October 2014, the size of the Fed’s balance sheet had been relatively stable at $4.5 trillion, as the central bank was reinvesting the proceeds of maturing securities. The Fed announced a policy framework for reducing the size of its balance sheet in June 2017, and began implementing the program in October. Rather than selling securities outright, the Fed is allowing $10 billion of holdings to mature each month ($6 billion of Treasuries and $4 billion of mortgage-backed securities [MBS]) for the first three months, with the amount increasing by $10 billion each month thereafter until reaching a cap of $50 billion per month in late 2018.

The impact of the Fed’s program has already begun to show up in the data (specifically the Fed’s weekly balance sheet data), as have charts depicting the effects. The chart below shows the size of the Fed’s Treasury holdings over the past three years, and in this context, even one month of normalization looks like a fairly big drawdown in balance sheet assets.

However, extending the above chart by just one year, as shown below, makes the gradual nature of the program clear. In this context, the move looks very small. If we were to extend the date out to 10 years to show the full impact of all QE programs (instead of just a portion of QE3), the move is almost imperceptible.

The Fed gave details of its balance sheet normalization plan several months ahead of its implementation to give markets time to digest the potential impacts. This transparency, combined with a go-slow approach and language stating that they would consider reversing the program if economic conditions deteriorate, has mitigated any meaningful, negative impact to either Treasury or MBS markets to date.

 

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