The Federal Reserve announced it is modifying the drawdown of its US$6.6 trillion balance sheet, citing evidence of tightening money market liquidity and declining bank reserve levels. Effective December 1, the Fed will cease allowing up to US$5 billion in Treasury securities to mature each month without replacement. Instead, it will maintain its stock of government bonds by rolling over maturing Treasuries. This shift comes amid increasing signs of pressure in money markets, highlighted by record borrowing from the central bank’s Standing Repo Facility. This facility provides rapid loans to eligible firms, signaling tighter market liquidity.
The Fed will maintain its current plan to allow up to US$35 billion in mortgage-backed securities (MBS) to expire monthly, a target never fully achieved in over three years of reductions. Starting December 1, all proceeds from maturing MBS will be reinvested into Treasury bills. At its Federal Open Market Committee meeting, the central bank also trimmed the fed funds rate by a quarter percentage point, setting a new range between 3.75% and 4.00%. The interest on reserve balances rate (IORB) was adjusted to 3.90% from 4.15%, while the reverse repo rate moved to 3.75% from 4.00%.
The move to adjust quantitative tightening (QT) was widely anticipated, given mounting signs of stress in money markets. The Fed’s Standing Repo Facility has seen a surge in activity, reaching its highest usage ever. Simultaneously, the federal funds rate has been trending higher within its range as other short-term lending rates have risen. The Fed’s QT aimed to reverse the liquidity surge introduced during the COVID-19 pandemic, which saw the Fed’s holdings more than double to US$9 trillion by mid-2022.
QT has steadily reduced Fed holdings from their peak, primarily by diminishing excess cash parked in the reverse repo facility. As reverse repo usage declined, QT has been lowering reserve levels, though they remain within a stable range. Analysts anticipate the Fed may soon need to resume bond purchases to maintain adequate liquidity in an expanding economy, shifting from stimulus to liquidity management.
