The Fed’s balance sheet reduction has been proceeding as planned and reserve supply remains above ample, said Julie Remache, deputy SOMA manager and head of Market and Portfolio Analysis on the Open Market Trading Desk at the New York Federal Reserve in a recent speech.
The reserve-draining impact of runoff has been almost entirely offset by the reserve-adding impact of the drop in ON RRP usage. And, as a result, reserve balances are nearly unchanged since runoff started. Nevertheless, there are incremental signs of a shift in money market conditions.
The distribution of traded repo rates, for example, has moved upward, and repo rate volatility has periodically reemerged around regulatory reporting dates or Treasury settlement dates. However, there is no sustained material upward pressure in the federal funds market.
“As balance sheet reduction continues, we expect to see further declines in ON RRP, and reserve balances will likely begin to decrease at some point. As this proceeds, we will continue to monitor conditions in a range of money markets,” she said.
Amid these developments, there has been increased focus on the factors that would guide a decision to slow the pace of SOMA runoff. The FOMC will ultimately determine the future evolution of the balance sheet, including when to slow and when to stop the runoff of the securities portfolio.
“A return to the $4.2 trillion pre-Covid balance sheet is very unlikely. In the coming months, we will be monitoring money markets for emerging pressures, which may at some point indicate we’re getting closer to a level that is somewhat above ample. Eventually, the balance sheet will have to increase over time to accommodate the long-term growth of the financial system—and with it the demand for Fed liabilities. In order to meet this growth over time, reserve management purchases will be needed to maintain an ample supply of reserves,” she said.