The Federal Reserve is operating with an abundant, or more than ample, level of reserves, and securities holdings are tilted toward longer-dated maturities. The balance sheet is shrinking to get back to a size consistent with an ample reserves system, said “Christopher Waller, member of the Board of Governors of the Federal Reserve System, in a recent speech.
“Given my rough estimate of the level of reserves needed to be ample, I believe we can likely continue to let a share of maturing and prepaying securities roll off our balance sheet for some time, reducing reserve balances,” Waller said.
The bigger problem from Waller’s point of view is that balance is that the maturity structure of Fed assets to support an ample-reserves system is not well matched.
“We have far too many long-term assets on our balance sheet relative to my arguments for how to structure the balance sheet. I argued that long-term assets should only be held against currency liabilities, which are $2.3 trillion. But we hold about $2.3 trillion in agency mortgage-backed securities alone! So the duration of our asset portfolio is far too long for the liabilities we need to hold for an ample-reserves system,” Waller said.
If the Fed moved forward with a maturity-matching strategy, it would hold about half of its Treasury securities in shorter-dated bills. There have been some advocates who support moving toward the Federal Reserve having a Treasury securities portfolio whose composition mimics the breakdown, or “universe,” of total Treasury securities outstanding.
Waller explained that this would mean having about 20% of the Fed’s current balance sheet in bills. The argument for this maturity structure is that with this approach, the Fed’s holdings would not be putting pressure on any one segment of the yield curve.
“This is a valid argument, but it would put more duration on our balance sheet and expose the Fed to potential income losses, as we have witnessed the past few years, he said in the speech. “Maybe that is a tradeoff we should make to avoid distorting our demand for Treasury securities relative to the market’s demand. In the end, I support continuing the conversation about what the ultimate composition should be.”