Coming in earlier than many expected, the Fed for the first time laid out how it plans to “normalize” its balance sheet which it expects to reduce by trimming reinvestments in TSYs at a rate of $ 6Bn/month initially, and MBS at $ 4Bn/month, or a total of $ 10bn/month, and will increase the reinvestment caps in steps of 10bn at 3 month intervals over 12 months until it reaches a total 50bn per month.

Indicatively this is well below Goldman’s expectation of $ 10bn and $ 5bn initial caps for TSYs and MBS, as we showed over the weekend.

As its said in the addendum to the materials, “the Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated” with directions to read a Policy Addendum.

As the Fed further explains, the reinvestment cap will hit TSYs at the tune of $ 6Bn per month initially, and MBS at $ 4Bn:

  • for payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be USD6bn per month initially and will increase in steps of USD6bn at 3m intervals over 12m until it reaches 30bn per month.
  • For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $ 4 billion per month initially and will increase in steps of $ 4 billion at three-month intervals over 12 months until it reaches $ 20 billion per month.

This level of detail provided is the main surprise so far and what traders are most focused on, because as Citi notes, it as moving forward the chances for a balance sheet announcement from December. More questions on how soon implementation would follow.

Indicatively, this is what Goldman expected:

Process for phasing out reinvestment: The May minutes signaled that the committee will preannounce a schedule of gradually increasing caps to limit the amounts of securities that can run off in any given month. Our assumption is that that the initial caps are $ 10 billion a month for UST and $ 5 billion a month for MBS. The caps would rise each quarter by $ 10 billion and $ 5 billion to $ 40 billion and $ 20 billion respectively. Caps allow for a gradual runoff and deal with the variability associated with MBS prepayment and the irregular monthly schedule of maturing assets. The caps will remain in place after the phase-in but then only bind in roughly a third of the months for Treasuries until mid-2020 when the balance sheet reaches its projected terminal size.

We will provide further details shortly

For now, the full statement is below:

All participants agreed to augment the Committee’s Policy Normalization Principles and Plans by providing the following additional details regarding the approach the FOMC intends to use to reduce the Federal Reserve’s holdings of Treasury and agency securities once normalization of the level of the federal funds rate is well under way.

 

The Committee intends to gradually reduce the Federal Reserve’s securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.

  • For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $ 6 billion per month initially and will increase in steps of $ 6 billion at three-month intervals over 12 months until it reaches $ 30 billion per month.
  • For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $ 4 billion per month initially and will increase in steps of $ 4 billion at three-month intervals over 12 months until it reaches $ 20 billion per month.
  • The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve’s securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.

Gradually reducing the Federal Reserve’s securities holdings will result in a declining supply of reserve balances. The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system’s demand for reserve balances and the Committee’s decisions about how to implement monetary policy most efficiently and effectively in the future. The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization.

 

The Committee affirms that changing the target range for the federal funds rate is its primary means of adjusting the stance of monetary policy. However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee’s target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.


Source: http://capitalisthq.com/fed-reveals-balance-sheet-normalization-schedule-will-reduce-reinvestments-by-10bnmonth-2/

Advertisements