(Bloomberg) — The Federal Reserve has shed about $1 trillion in bond holdings since it began tapering its bond holdings last year, with no signs of strain in financial markets as policymakers last reined in the program.
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The system’s open market account – the name of the central bank’s asset portfolio – now stands at $7.4 trillion, compared with a record $8.4 trillion reached in April last year, New York Fed data shows. As part of its largest monetary stimulus campaign in decades, the Fed will mature up to $60 billion in Treasuries and $35 billion in mortgage-backed debt each month.
Those shrinking holdings force the Treasury Department to rely more on the private sector to take on federal debt. And so far, money market funds and other buyers of Treasury bills have been touting Washington as a key part of its bid for better funding. After the debt-limit battle, the need to replenish cash has become even greater.
Blake Gwin, head of U.S. interest rate strategy at RBC Capital Markets, said: “The Fed’s debt meltdown so far has been painless. “We don’t see a big impact of QT on the marketplace,” he said, referring to quantitative tightening, the contractionary term of the Fed’s balance sheet.
That compares to 2019, when the Fed was reeling during its first round of competition with QT. At the time, the program was depleting bank reserves, a move Chairman Jerome Powell admitted at a congressional hearing in June that blindsided policymakers.
Gwynne highlighted that the reserves have not changed significantly in recent months. Instead, QT took a bite out of the institution where money-market funds put some of their money — the Fed’s reverse repurchase program, known as RRP. That account is now about $1.6 trillion — or roughly half the size of bank reserves — after peaking at about $2.6 trillion in December.
Read More: Use of Fed Repo Facility Extends Recession as T-Bills Draw Cash
As the Fed’s QT continues, it will eat more into reserves, posing a further challenge to markets. Another key variable is the Treasury’s decision to sell its expanding financing needs, driven by high fiscal deficits. High-yielding T-bills have been in high demand lately, but the Treasury is drawing attention to Washington’s debt orientation and is lifting sales of long-term securities.
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The Treasury earlier in August began raising its note rates and bond auctions for the first time in more than two years. Gwynn predicts similar action in November and another, albeit slightly smaller, one in February.
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“How the Treasury tries to offset the Fed’s losses is a key part of measuring how QT will affect the markets,” he said.
–With help from Elizabeth Stanton.
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