Fed Minutes Show Debate Over Balance Sheet Runoff Continues

Several participants at the Federal Reserve’s September policy meeting said it was important to continue monitoring money-market conditions and evaluate how close bank reserves are to their “ample” level, as the central bank continues to unwind its massive portfolio of securities. 

The remarks come as prolonged funding pressures in US money markets, just as bank reserves held at the Fed are dwindling, are suggesting the central bank may be getting closer to ending its balance sheet runoff. 

A few participants noted that the Standing Repo Facility — the Fed’s liquidity backstop — would help keep the federal funds rate within its target range and ensure that temporary pressures in money markets wouldn’t disrupt the ongoing balance-sheet reduction, according to the minutes of the Sept. 16-17 gathering released Wednesday.  

As the Treasury has ramped up debt issuance to rebuild its cash balance following the increase in the debt ceiling in July, it’s draining liquidity from other liabilities on the Fed’s ledger, like the central bank’s overnight reverse repurchase agreement facility and bank reserves. On Tuesday, Treasury said it would sell a record amount of bills in coming days and is expected to boost auction sizes further later this week. 

The flurry of Treasury bill issuance is dragging yields higher across a range of instruments. Interest-rate benchmarks tied to overnight repurchase agreements collateralized by US Treasuries are hovering around the Fed’s interest on reserve balances rate, known as IORB, an indication that higher funding costs are here to stay.

Meanwhile, bank reserves have been steadily declining, falling below $3 trillion, the lowest level since January, according to the latest data.

Fed officials have since 2022 been winding down the central bank’s balance sheet — a process known as quantitative tightening — reversing trillions of dollars of asset purchases designed to stimulate the economy after the pandemic struck. Earlier this year, the Fed slowed the pace by reducing the amount of bond holdings it lets roll off every month.

Fed Chair Jerome Powell said last month bank reserve balances are still “abundant” and have yet to reach the minimum level needed to cushion against market disruptions, though he acknowledged they’re getting closer. Fed Governor Christopher Waller earlier estimated that level — known as ample — at $2.7 trillion. 

During the meeting, Julie Remache, deputy manager of the System Open Market Account, noted that if the balance-sheet runoff were to continue at the current pace, the Fed’s portfolio is expected to decline to just over $6 trillion by the end of March. As a result, Remache expected reserves to be close to the $2.8 trillion range by the end of March 2026. 

Still, central bank officials appear divided on how much the Fed should tighten its balance sheet. Fed Vice Chair for Supervision Michelle Bowman said at the end of September the Fed should seek to achieve the smallest balance sheet possible, with reserve balances at a level closer to scarce than ample. That’s in contrast with Powell, Remache and others who have suggested that the runoff should end once reserves are near ample, likely by the end of this year.