It is unlikely that the Federal Reserve will abruptly announce a balance sheet reduction ending in September or earlier, Citi economists said in a Wednesday note.
The Wall Street bank has previously maintained that the Federal Reserve would likely halt balance sheet reduction before reserves reach the “somewhat above” ample level, particularly in the event of a recession.
Last year, during the July 2023 press conference, Fed Chair Powell mentioned that in “a world where things are okay” and the Fed is merely normalizing rates lower, balance sheet reduction could continue even as policy rates decrease.
However, this narrative could change “if there is a material weakening in the labor market and activity,” Citi economists note.
With the latest jobs report revealing more labor market weakness than anticipated by most economists and the Fed, it has become more probable that the policymakers might signal at the September meeting that the end of balance sheet reduction is nearing, potentially by December.
“If activity and labor market data deteriorate further in coming weeks, a sooner end of the balance sheet could be signaled at the September meeting but an abrupt end in September would not be our base case unless acute liquidity issues arise,” economists continued.
“We do not expect any major liquidity pressures in the coming months with reserves still at abundant levels, reverse repo balances still ~ $290bln and the standing repo facility serving as a backstop.”
In the week ending July 31, the Fed’s balance sheet saw a reduction of approximately $27 billion, with $10 billion in Treasuries and $14 billion in mortgage-backed securities rolling off.
On the liability side, the Treasury’s cash account (TGA) surged to $854 billion on July 31 due to month-end settlements but has since fallen to $759 billion. The Treasury has indicated that the TGA will reach around $850 billion by the end of September, decreasing to $700 billion by year-end as the debt limit suspension ends.
Reverse repo (RRP) balances have remained more persistent than expected, despite rising SOFR rates, likely due to intermediation and counterparty limit issues. Because of this and strong TGA liquidity, bank reserves fell to $3.178 trillion from $3.276 trillion during the same week.
