Recap of changes in Fed’s program to reduce reserve holdings

Back at his March 20 post-FOMC meeting press brief, Chair Jerome Powell signaled that discussions regarding the program to reduce the Fed’s holdings of US treasuries and agency mortgage-backed securities were well advance and would be made public “soon”. The minutes of the March 19-20 meeting offered some details. At the April 30-May 1 meeting, the FOMC made its final decision and announced changes to start in June 2024. What Powell has called the “brisk pace” of reductions in the size of the Fed’s will soon give way to more incremental progress.

To recap, the program began in June 2022. The Fed announced reinvestment caps of $30.0 billion for US treasuries and $17.5 billion in agency MBS for June, July, and August, to increase in September to $60.0 billion for US treasuries and $35.0 billion for agency MBS. Those caps were unchanged up to now. Starting in June 2024, the cap on reinvestments of US treasuries is reduced substantially to $25.0 billion while the cap of $35.0 billion in agency MBS is unchanged.

Fed policymakers have been explicit that the change in the cap is not intended as a monetary policy action to affect market conditions and/or the change the amount of support given to the US economy through the credit transmission channel. There may be some small impact as the reductions in the size of the balance sheet slow, but these are incidental.

The intent is to smooth the transition from an environment of “abundant” reserves to an “ample” one similar to prior to the pandemic. It is also intended to assist in the process of getting the Fed’s holdings back to an all-treasuries composition. This is likely to take some time as reinvestments of agency MBS have rarely met the cap of $30 billion in any one month. The agency MBS purchased during the recent expansion of the balance sheet were bought at a time when mortgage borrowers were getting historically low rates. Many of those mortgage holders are reluctant to give up their 3-, 4-, and 5- percent rates. The mortgages behind the securities are far from maturity or being paid off. Homeowners are not putting their properties on the market or refinancing at higher rates unless there is a pressing need to take out some equity.

Since June 2022, the program has been visibly chipping away at the size of the balance sheet. The weekly Treasury data put holdings of US treasuries and agency MBS at $8.480 trillion on June 1, 2022. As of the May 29, 2024 report, the balance is down roughly $1.6 trillion to $6.856 trillion. How much further it will decline has yet to be determined. Given that it will take years to see another sizeable dent in the balance sheet total, it isn’t an urgent question. For now, policymakers will stick with the formula that the ultimate size will be determined by maintaining an ample reserves environment that will cushion periods of instability.