Most bond markets around the world did not have much to focus on this week except for the Federal Open Markets Committee (FOMC) September meeting. No change was expected to be made to the federal funds rate but a statement regarding the reduction of the Fed’s balance sheet was anticipated.
As it turned out, the market got what it expected. There was no change to the official rate and, in October, the Fed will begin its balance sheet normalisation programme. It will reduce its re-investment of mature Treasury bonds securities by USD$6 billion per month and of mature mortgage-backed securities by $4 billion per month. Every three months, these amounts will be increased by additional USD$6 billion and $4 billion per month respectively until the Fed’s holdings of Treasury bonds are being wound down by a maximum of USD$30 billion per month and its holdings of mortgage-backed securities are being wound down by a maximum of USD$20 billion per month.
While this may sound like a lot, the U.S Fed increased its balance sheet from around USD$800 billion in 2007 to the current USD$4.5 trillion by purchasing Treasury bonds and asset-backed securities. At USD$50 billion per month, a lot of months will be needed to shrink the Fed’s balance sheet back to 2007 levels.
There has been some opposition to such a plan. In January, former Fed chief Ben Bernanke wrote a piece for the Brookings Institute in which he estimated the optimal size of the balance sheet is currently “greater than $2.5 trillion and may reach $4 trillion or more over the next decade.” He said the U.S. economy is “growing into” the Fed’s $4.5 trillion balance sheet, “reducing the need for rapid shrinkage over the next few years.” He is probably not the only person who would like to avoid a reduction in the amount of base money in the U.S. banking system.