The Hidden Dangers in the Fed's Balance-Sheet Reduction

Source: American Banker

The Federal Reserve's balance sheet runoff is picking up steam after its monthly cap on unreplaced maturities doubled to $95 billion last month. Last week alone, it shed $37 billion of assets. 

As the central bank ramps up its effort to reduce its holdings — currently totalling more than $8.7 trillion — to a more manageable level, it gives rise to questions about how much runoff the banking system will tolerate and how potential regulatory changes might pave the wave to a smoother balance sheet reduction than in the past.

The Fed has been steadfast in its commitment to tightening monetary policy until inflation abates, but it remains unclear if it can avoid a repeat of the September 2019 tightening cycle, when a scarcity of reserves forced the Fed to expand its balance sheet again. The threat is punctuated by last month's U.K. government debt crisis that forced the Bank of England to intervene in the bond market to avoid a financial catastrophe.