By Michael S. Derby
(Reuters) – Uncertainty over how the U.S. Treasury will manage debt issuance over the next few months drove some Federal Reserve officials to contemplate at their last policy meeting slowing or pausing the ongoing drawdown of their balance sheet until greater clarity arrives.
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.
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. That appears to be influencing at least some Fed officials’ thinking, even as the ultimate endgame for QT remains uncertain.
(Reporting By Michael S. Derby and Dan Burns; Editing by Andrea Ricci)
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