The decision to very nearly stop the drawdown of bonds owned by the Fed followed a presentation by a New York Fed official responsible for implementing monetary policy, the Federal Open Market Committee meeting minutes noted.

That official laid out the case for slowing the runoff while there was uncertainty over how soon Congress would raise the federal debt ceiling. "The manager noted that either pausing or sufficiently slowing runoff would provide meaningful insurance" against the possibility of reserves dropping quickly after a debt ceiling resolution is reached, the minutes said.

At that March 18-19 policy meeting, the central bank said that it would lower the cap on how many Treasury securities it would allow to run off from the previous $25 billion per month to $5 billion as of this month, while preserving the $35 billion cap on the mortgage bond drawdown it has already struggled to meet.

The slowdown in what's called quantitative tightening, or QT, had been widely expected. The near pause allows the Fed to navigate a period of money market uncertainty due to government cash management issues amid a period of legally limited borrowing.

The New York Fed official briefing central bankers described how Treasury debt management activities will make it hard to measure the true level of market liquidity and that potentially increased the risk of the Fed overshooting on QT. Slowing the drawdown would deal with that potential trouble spot, the minutes said.

STEADY STATE

The QT slowdown was opposed by Fed Governor Christopher Waller, who has often been skeptical of using the Fed’s securities holdings as a policy tool, in favor of proceeding with the rundown at an unchanged pace.

The minutes showed that Waller had more company than the FOMC vote indicated. Ahead of the Fed meeting, Cleveland Fed President Beth Hammack, who does not vote this year, said in a Reuters interview that she was leaning toward pressing forward on QT and allowing Fed liquidity tools to deal with any market volatility around debt ceiling market impacts.

Waller had also noted in a statement justifying his dissent that he'd like to see a more formal plan from the Fed about how it would use its various tools to deal with money market volatility, an issue that's been thus far addressed in an ad hoc way.

To that end, the minutes noted, "a number of participants commented that the Committee's existing tools could also be used to help address potential disruptions to the market for reserves."

The Fed’s goal with QT has been to withdraw enough liquidity from the financial system to allow for normal short-term interest rate volatility and to maintain firm control over the federal funds rate, the central bank’s chief lever to influence the economy. Officials are looking to markets for signals about how much liquidity they can safely take out but as the Treasury wrestles with the debt ceiling those signals are obscured.

Without the debt ceiling issue, the Fed may well have remained full steam ahead on QT. Speaking last month after the FOMC meeting, Fed Chair Jerome Powell said market indications are that “the quantity of reserves remains abundant.”

The debt limit issue, absent some immediate action from Congress, is likely to remain in place for some time. Last month the Congressional Budget Office said the government's means to manage cash while borrowing is capped will be exhausted by August or September.

EXTENDED SLOWDOWN

Powell appeared to argue at the post-FOMC meeting press conference that the reduced pace of QT is the new normal even after Congress lifts the debt ceiling because it allows for a more gradual approach to the point where QT would need to stop. “If you're cutting the pace of QT roughly in half, then the runway is probably doubled,” something that he said appealed to Fed policymakers. “It's a common-sense kind of a thing,” he added.

New York Fed President John Williams, speaking on Yahoo Finance on March 31, also saw longer-run value in the slower QT pace. As the end point looms eventually, “we're coming in at a slower speed and we can collect data, understand what's going on and avoid any unnecessary bumps along the way.”

Fed officials have said repeatedly that what happens with QT stands apart from the main thrust of monetary policy, which is tied to the level of the federal funds rate. The drawdown of the Fed’s balance sheet has taken central bank holdings from a peak of $9 trillion in 2022 to the current level of $6.8 trillion.

For some time, there’s been little clarity on how far the Fed can take the QT process. A recent note from Goldman Sachs economists pegged the endpoint at some time in the third quarter of this year. Meanwhile, Morgan Stanley forecasters predicted QT could extend into next year now that the rundown has slowed.

One wrinkle for the QT outlook is the increasing stress faced by financial markets as President Donald Trump pursues an aggressive trade war against almost all of America’s major trading partners. His tariff regime and the uncertainty surrounding it have driven deep losses in stocks and, in the view of many economists, are putting the U.S. and other large nations on track for big economic downturns.

That’s driving markets to price in more Fed rate cuts. While the Fed is some way from the ultra-low rates that have in the past forced it to buy bonds as a form of stimulus, it’s possible an aggressive cutting scenario may again shift the outlook for Fed holdings and suggest a return to large-scale buying.