A Gradual Approach to Balance Sheet Reduction
Citi has recently released a report suggesting that if Wesh assumes the role of Fed Chair, the policy approach may lean toward a cautious, step-by-step reduction of the central bank's massive balance sheet. With the Fed's current assets reaching up to $6.6 trillion, any aggressive moves could risk destabilizing market liquidity.
The report emphasized that the volatile swings seen in the repo market last year have significantly raised the bar for restarting quantitative tightening (QT). Citi analysts believe the Federal Open Market Committee (FOMC) will prefer a more measured approach to avoid a repeat of liquidity strains.
Potential Strategies for Reduction
While the overall direction is toward shrinking the balance sheet, there are several possible paths to achieve this. One is the potential replacement of long-term Treasuries with short-term debt, effectively shortening the average maturity of the Fed's holdings and reducing systemic risk exposure.
Another option could involve a gradual tapering of the monthly Treasury purchase program, which currently stands at around $40 billion. Analysts suggest this figure might be lowered to $200 billion or even halted altogether over time.
- Adjusting the maturity structure of Treasuries
- Reducing bond purchase volumes
- Allowing mortgage-backed securities to mature without reinvestment
Expectations for the Coming Months
According to Citi's forecast, starting from mid-April, the Fed may begin to slow its bond purchases and maintain a pace of approximately $20 billion per month through year-end. This gradual approach would provide markets with adequate time to adjust while enabling the Fed to manage its balance sheet more effectively.