MNI: Fed's Logan: Reserves More Than Ample, QT Can Continue

MNI (WASHINGTON) - U.S. balance sheet normalization can run on as the Federal Reserve lowers rates toward a more neutral level, and reserve balances are more than ample to ensure rate control, Dallas Fed President Lorie Logan said Monday. 

Temporary money market rate pressures such as those seen at the end of the third quarter are to be expected as liquidity declines, she added. 

"At present, liquidity appears to be more than ample. Reserve balances are around USD3.2 trillion, compared with around USD1.7 trillion in early 2020. The economy and financial system have grown, and the dash for cash at the start of the pandemic as well as the banking stresses in March 2023 may have led banks to increase their demand for liquidity. Still, I think it’s unlikely banks’ liquidity demand has nearly doubled in half a decade," she said in remarks prepared for Securities Industry and Financial Markets Association's annual meeting in New York. 

"As in the previous episode of balance sheet normalization in 2018 and early 2019, we are likely to continue to see occasional, modest rate pressures as our balance sheet shrinks. Such temporary rate pressures can be price signals that help market participants redistribute liquidity to the places where it’s needed most. And from a policy perspective, I think it’s important to tolerate normal, modest, temporary pressures of this type so we can get to an efficient balance sheet size." 

PORTFOLIO CHANGES

The overnight reverse repo facility offers another sign that liquidity remains more than ample and provide a buffer of additional excess liquidity, Logan said. 

In the long run Logan expects the facility to operate with "only negligible balances," reflecting its purpose as a backstop, she said. 

"Meaningful ON RRP balances should not form a permanent fixture on the Fed’s balance sheet, in my view," she said. 

Over the long run, the FOMC could debate moving to a more neutral portfolio, with a maturity composition similar to that of the Treasury universe or to tilt toward shorter maturities, Logan said. Officials may also debate whether to sell MBS, "but that's not a near-term issue in my view," she said. 

The FOMC could also consider centrally clearing its standing repo facility and other open market operations to further enhance the effectiveness of its tools, she said. (See: MNI: Fed's Standing Repo Facility Tested By Market Rate Spike)

GRADUAL CUTS

Logan also reiterated the U.S. economy is strong and stable and the central bank should be data dependent in deciding how quickly to cut rates. 

"Downside risks to the labor market have increased, balanced against diminished but still real upside risks to inflation. And many of these risks are complex to assess and measure," she said. 

"If the economy evolves as I currently expect, a strategy of gradually lowering the policy rate toward a more normal or neutral level can help manage the risks and achieve our goals. However, any number of shocks could influence what that path to normal will look like, how fast policy should move and where rates should settle. In my view, the FOMC will need to remain nimble and willing to adjust if appropriate."