According to Citi economists in a note on Wednesday, it’s unlikely that the Federal Reserve will suddenly announce an end to balance sheet reduction by September or earlier.
Previously, Citi has suggested that the Fed would probably pause the balance sheet reduction before reserves hit what they consider a “somewhat above” ample level, especially if a recession hits.
Last year, during the July 2023 press conference, Fed Chair Powell mentioned that in a stable economic environment where the Fed is just normalizing rates, the balance sheet reduction could continue even if policy rates are lowered.
However, this view might shift if there’s a significant decline in the labor market and economic activity, as noted by Citi economists.
With the latest jobs report showing more weakness in the labor market than most economists and the Fed expected, it’s now more likely that the Fed might signal at their September meeting that balance sheet reduction could wrap up soon, possibly by December.
“If economic activity and labor market data weaken further in the coming weeks, the Fed might hint at ending the balance sheet reduction sooner during the September meeting. However, we don’t expect an abrupt end in September unless there are serious liquidity issues,” the economists said.
They added, “We don’t foresee major liquidity pressures in the near future. Reserves are still plentiful, reverse repo balances are around $290 billion, and the standing repo facility is available as a backup.”
In the week ending July 31, the Fed’s balance sheet shrank by about $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) jumped to $854 billion by July 31 due to month-end settlements but has since dropped to $759 billion. The Treasury expects the TGA to be around $850 billion by the end of September and then decrease to $700 billion by the end of the year as the debt limit suspension concludes.
Reverse repo (RRP) balances have remained higher than expected, even with rising SOFR rates, likely due to issues with intermediation and counterparty limits. As a result, and with strong TGA liquidity, bank reserves fell to $3.178 trillion from $3.276 trillion during the same time
