Expectations for the future path of the Federal Reserve's balance sheet drawdown process have been scrambled in the wake of last week's readout of January's policy meeting, which showed central bankers concerned about how the effort to shed bonds might collide with dynamics around the federal debt ceiling.
This fragmentation follows the release of the minutes of the policy-setting Federal Open Market Committee's January 28-29 meeting, when "various" policymakers said they were open to pausing or slowing the reduction of Fed-owned Treasury and mortgage bonds to navigate uncertain money market conditions as Congress sorts out government finances and a statutory cap on the federal debt that came back into force last month.
The Treasury Department is already employing "extraordinary measures" to continue most normal debt issuance under the limit, but there is a wide range of estimates - stretching into mid-summer - for when it runs out of wiggle room.
As a result, money market conditions may be unsettled for some time, which increases the risk the Fed could go too far with liquidity withdrawals, something central bank officials do not want and which opens the door to a shift in the QT process.
Reading the levels of market liquidity is challenging because Treasury's actions to keep the government funded while the borrowing cap is in place will push money out into the financial system and boost what have been steady reserve levels, analysts say, while a resolution of that issue will then quickly pull cash back out.
STOP, SLOW OR KEEP GOING
"We assume that the FOMC would be inclined to 'slow' the overall pace of runoffs rather than freeze them altogether," analysts at Wrightson ICAP said. An outright pause would require some purchasing of Treasury debt to keep Fed holdings steady, and "the communications hurdles stemming from any shift in the pace of QT are daunting enough without having to explain the introduction of a temporary new asset purchase program as well."
Barclays analysts are holding to their view that QT will end in September or October, noting "it may not make sense to pause QT at say, the March or May meetings, only to briefly restart and end asset roll-offs in September or October."
"Our sense is that the concern expressed in the January FOMC minutes may be less about the level of bank reserves and more about how quickly they fall between August and October," they said.
Meanwhile, other analysts believe that halting QT would risk bringing the effort to a close earlier than the Fed desires.
"Pausing potentially turns into a full stop if not resumed," analysts at research firm LH Meyer said. "Resumption might prove tricky, especially if the debt-limit episode was bruising in retrospect for market-function confidence."
That argues for a QT slowdown while the debt ceiling episode plays out, they said.
READING LIQUIDITY
The Fed had already been struggling to glean how far it could go with QT without causing undue money market volatility and upending its control of the federal funds rate, its chief monetary policy tool. Fed officials had noted recently they still saw room to run and an update on market liquidity showed no issues calling for a stop.
A survey of major banks and money managers conducted ahead of last month's policy meeting showed respondents eyeing a June-to-July stopping point for QT, with Fed holdings, now down to about $6.8 trillion from a peak of about $9 trillion in 2022, falling to $6.4 trillion.
Reserves are expected to be at $3.125 trillion by the end of the QT process, compared with $3.3 trillion now, while the level of the Fed's reverse repo facility, a proxy of excess liquidity, is estimated to be $125 billion. The reverse repo facility's level, however, has remained below $100 billion throughout February.
