MNI: Fed Could Soon Taper QT But Halt Further Off- Ex-Staffers

The Federal Reserve could soon start to slow the pace of quantitative tightening, but officials will aim to press on with some form of balance sheet reduction for as long as bank reserves are ample and there are no signs of a hard landing, former New York Fed staffers told MNI.

Policymakers put markets on notice this month after minutes to the central bank's December meeting showed several FOMC members wanted to "begin to discuss the technical factors that would guide a decision to slow the pace of runoff well before such a decision was reached."

The surprise warning led investors to bring forward expectations for the start of such a taper to as early as March or May, and the ex-staffers told MNI taper details will be debated at upcoming meetings and could be unveiled in the first half of the year. Fed officials are keen to keep the process running until reserves are "somewhat above" ample, the ex-staffers said.

"The discussion will become relevant in March — it’s already been noted in the minutes so it will come up at the next press conference," former New York Fed economist Gianluca Benigno said in an interview.

"We have heard from a range of Fed speakers including Chair Powell that reserve levels are very ample, and we have also heard comments on tapering QT, " former New York Fed markets desk trader Joseph Wang told MNI. "This could be reconciled with on-going QT at a slower pace, but without a pre-set end date." (See MNI INTERVIEW: Clearing Rule To Boost Treasury Liquidity)

Dallas Fed President Lorie Logan, who previously headed the markets desk at the New York Fed, argued earlier this month that slowing QT could reduce the likelihood that the Fed would have to stop the process prematurely, a reference to the 2019 repo market crisis that forced the central bank to make a sudden switch back to bond purchases.

The pandemic round of QT has been more aggressive than in 2019, as the level of reserves and cash parked in the overnight reserve repo facility are also much higher as a percentage of GDP by comparison. Since mid-2022, Fed assets have shrunk by USD1.3 trillion while bank reserves have actually risen by USD350 billion to around USD3.5 trillion.

ON RRP

Logan suggested she would favor slowing runoffs when overnight reverse repo balances approach a "low level," which according to Wall Street analysts could come as early mid-year. Her reasoning is the ON RRP facility can serve as a buffer for individual banks experiencing a scarcity of reserves, until it approaches zero, former staffers said.

"A near-fully drained ON RRP is likely a sign that market liquidity levels are sufficiently tight and that the Fed can then implement a modification to QT," said Rick Roberts, a former New York Fed executive. "Before introducing QT changes, let’s ensure we are comfortable with the near-zero take-up environment where the change will occur."

New York Fed President John Williams said Wednesday "as the balance sheet continues to shrink and usage of the ON RRP continues to decline, we will closely monitor money market conditions and the demand for reserves."

But some ex-staffers thought the timing of the taper will be determined by aggregate levels of liquidity, and do not necessarily need to be tied to the size of the ON RRP facility. Signs of reserves scarcity could include higher repo rates and higher fed funds rates compared to the Fed's interest on reserves or increased borrowing from Federal Home Loan Banks or the Standing Repo Facility. The New York Fed last year projected QT to end in mid-2025 with reserve balances at about USD2.5 trillion.

"In an ample reserves system, the best way to understand it is probably to taper and see what is happening," Benigno said. "It’s not obvious to me that you need to wait for RRP to drop before tapering QT."