Author: Michael S. Derby
NEW YORK (Reuters) - The U.S. central bank faces no imminent pressure to stop reducing its holdings of Treasuries and mortgage-backed securities, data from the New York Federal Reserve showed on Thursday.
The region's central bank reported that its latest measure of reserve demand elasticity was essentially stable at -0.04 as of January 7 relative to recent readings, saying "this estimate suggests reserves remain ample."
For the Fed, ample reserve levels mean that liquidity in the financial system remains strong enough that the Fed can continue to shrink its balance sheet by allowing some of the Treasury and mortgage securities it owns to mature without being replaced.
The process, known as quantitative tightening (QT), which began in 2022, has taken the Fed's holdings from a peak of about $9 trillion in the summer of 2022 to current levels of just under $7 trillion.
Fed officials have been unsure how much further they can reduce their holdings. But to avoid a repeat of the events of fall 2019, when the final chapter of QT unexpectedly withdrew too much liquidity and forced central banks to intervene, they learned from that event.
The reserve demand elasticity metric helps gauge liquidity conditions and address shortages ahead of time with strong lead times. The Fed also slowed the pace of QT withdrawals and established a facility called the Standing Repo Facility, which provides quick cash to eligible banks to quickly resolve any market problems.
Fed officials acknowledge that the outlook for quantitative easing is uncertain, but they currently appear to see no need to change strategy.
"Controversial"
New York Fed President John Williams told reporters on Wednesday that the transition from late 2024 to 2025 is "very smooth," pointing to a potentially volatile period for markets. He said he "didn't see any concrete indication" that reserve levels had contracted to the point where the Fed would have a more difficult time managing the setting of the federal funds rate, its main tool for influencing the economy.
Williams added that "I can't predict" when QT will end, but noted that the central bank has taken steps to reduce the chance of QT occurring suddenly.
Wall Street has been pushing back on expectations for the end of QT. New York Fed market surveys show major banks expect June to be a stopping point, a slightly longer term than recent expectations.
However, Barclays analysts see a longer runway.
"The debate over when QT will end is endless and almost fruitless, like counting the number of angels that can dance on the head of a pin," they said in a note. "As the minutes of the December (Fed meeting) There is no mention of QT and we (modestly) push back our forecast to the end of September."
Ending quantitative easing may depend on further reducing the size of the Fed's reverse repurchase facility. By then, fairly stable bank reserve levels are likely to decline. Compared with the current level of $3.3 trillion, the New York Fed's survey of banks ahead of its December 17-18 policy meeting projects that by the end of QT, Fed reserves will reach $3.125 trillion, with total Fed holdings Reaching $6.375 trillion.
(Reporting by Michael S. Derby; Editing by Paul Simao)