MNI INTERVIEW2: Fed Assets To Settle Near USD7T Post QT-Kaplan
The Fed needs to discuss when to stop QT, the former Dallas Fed president says.
The Federal Reserve’s balance sheet is likely to stabilize at around USD7 trillion when it finally terminates its QT program, a major increase from pre-pandemic levels that reflects the central bank’s increasing involvement in the functioning of money markets, former Dallas Fed President Robert Kaplan told MNI.
“The Fed has got a much bigger footprint – it’s very much in the plumbing of interbank lending markets,” Kaplan said. “My guess is they’ll have a hard time running the balance sheet much below USD7 trillion, with a dramatically larger balance sheet – much larger than GDP growth. This time, the balance sheet just got a lot bigger, but because of the plumbing implications they may not have a choice.”
Since the Fed began QT in mid-2022, balance sheet assets have shrunk by around USD1.3 trillion, leaving the balance sheet at USD7.5 trillion currently.
The debate over QT, which had been on the backburner last year, came back to life with a vengeance after December meeting minutes revealed several FOMC members wanted to debate when to begin to taper the balance sheet runoff.
IMPLICATIONS OF LARGER BALANCE SHEET
Some officials see a tapering of asset runoffs as a way for the Fed to more gradually feel its way toward the lowest level of comfortable reserves and avoid market disruption of the sort seen in 2019. Tapering could allow QT to last longer, officials say. (See MNI: Fed Could Soon Taper QT But Halt Further Off-Ex-Staffers)
“They need to start discussing how to stop QT. I wouldn’t be discussing it publicly but they need to discuss it. They’re going to look at all the plumbing issues,” ranging from the various repo facilities to the Treasury’s decision to issue fewer longer-dated bonds for fear of spooking jittery markets, Kaplan said.
A larger balance sheet has important implications for financial markets which could complicate the conduct of monetary policy, he added.
“They will have certain metrics they will use about short-term liquidity and usage of these facilities and whether we still have abundant reserves, whether that test is still being met. I have a funny feeling that once they get to around USD7 trillion we’ll get strange aberrations in overnight markets, that we’re going to have to stop there," he said. “The issue with having a USD7trillion balance sheet is that all things being equal it will be positive for risk assets and financial conditions."
Kaplan said the Fed should use its upcoming framework review to take a more measured approach to inflation and be more circumspect about committing policy makers to future actions.
He was involved in the last review and later dissented against forward guidance that he viewed as an excessively binding promise to keep rates at zero.
“The Fed ought to be much more careful about making present commitments to future actions. What I’d love to see in the new framework is more balance,” he said. (See MNI INTERVIEW: Fed Overtightened But Will Wait 'Til May-Harvey)