Fed officials, in minutes of the central bank’s January 28-29 Federal Open Market Committee meeting released on Wednesday, flagged the challenge of getting a clean read on market liquidity as the government wrangles over spending plans amid a legally mandated borrowing cap that will affect how the Treasury Department manages its cash.

“Regarding the potential for significant swings in reserves over coming months related to debt ceiling dynamics, various participants noted that it may be appropriate to consider pausing or slowing balance sheet runoff until the resolution of this event,” the minutes noted.

Fed officials had already been bracing for a period of uncertainty due to government financial management and had signaled in recent meeting minutes it would be hard to know whether financial markets had enough or too little liquidity. The issue is critical to the Fed’s ongoing effort to reduce its Treasury and mortgage bond holdings, in a process known as quantitative tightening, or QT.

HAZY HORIZON

QT has thus far shaved just over $2 trillion off Fed holdings, from a peak of $9 trillion in 2022. Fed officials have viewed the process as largely technical and while it was started amid Fed rate hikes, officials have long argued that their bond-holding drawdown has little measurable impact on the financial system.

That said, Fed officials are uncertain where to stop QT and are closely looking at a range of market liquidity measures to gauge when the process should come to an end. Fed Chair Jerome Powell noted last week that "I think we have a ways to go" on QT.

But at the same time, losing the ability to read the market increases the risk of overshooting on QT, which could bring undesirable volatility to money markets, akin to what happened in September 2019, the last time the Fed was engaged in QT. That appears to be influencing at least some Fed officials' thinking, even as the ultimate endgame for QT remains uncertain.

In an interview on Wednesday with Yahoo Finance, Atlanta Fed President Raphael Bostic said the Fed may be nearing levels where it can stop QT but added "there's not precision on that."

"I think it's going to be appropriate for us to be more cautious today and moving forward than we have been in the past six or eight months" as this process plays out, he said.

The minutes cited the official who implements monetary policy at the New York Fed as cautioning that assessing market liquidity by way of bank reserves is going to be challenging.

The minutes said "reserves might decline quickly upon resolution of the debt limit and, at the current pace of balance sheet runoff, might potentially reach levels below those viewed by the Committee as appropriate." If so, that could herald a swifter and more abrupt end to QT than what many in markets now expect.

The idea of a pause has not been on the minds of forecasters who track Fed balance sheet developments, and any such action could potentially represent a communications challenge for the central bank.

The meeting minutes also noted that even as Fed officials were debating the QT shift, market participants, in a survey conducted by the New York Fed ahead of the January FOMC meeting, saw a longer runway for QT.

"In their expectations of Federal Reserve balance sheet policy, survey respondents on average saw the process of runoff concluding by mid-2025, slightly later than they had previously expected," the minutes noted.

The minutes also showed officials weighing what their holdings will look like after QT ends, amid a push to get overall holdings to a primarily Treasury bond stance. "Many" Fed officials said they'd like to see the maturity of Fed bond holdings mirror the broader market, the minutes noted.