Housing Market Impact On Fed Balance Sheet

Investors are expecting the Fed to end QT by the end of 2019, but the Fed’s Minutes from the January meeting only mentioned that it would provide guidance soon. Powell’s speech on Tuesday gave us more clarity into the end of the unwind. It was a rare situation where he gave numerical details about the plan. Powell stated, “I would note that we are prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. In the longer run, the size of the balance sheet will be determined by the demand for Federal Reserve liabilities such as currency and bank reserves.” It’s fair to question when the ‘longer run’ is because there always seems to be some sort of financial disturbance in place. For example, the Fed adjusted its plans after the stock market volatility in Q4 2018.

Powell also stated bank reserves will likely end up at about $1 trillion plus a buffer by the time the unwind is over. As you can see from the chart below, bank reserves are now at $1.6 trillion.

(Click on image to enlarge)

Source: FRED

This means the unwind will likely end by the end of 2019. That’s because bank reserves are the only category of the balance sheet that is falling. ‘Other Fed liabilities’ have been stagnant and currency in circulation is increasing. We will get the specifics on the timing of the end of QT at the next Fed meeting in March.

The Fed currently holds $1.6 trillion in mortgage-backed securities. It wants to only hold treasuries. If it lets the MBS mature and reinvests the money into treasuries, it will take over 8 years to reach that goal. The Fed could sell MBS instead of waiting for them to mature. If the Fed uses the money to buy short term treasuries, which is mainly what it holds now, it leaves itself open to do an “Operation Twist” where it sells short-term bonds to buy long-term notes to impact the economy in an uncertain situation. In both scenarios, the Fed is a net buyer of treasuries for the next few years. It’s worth noting that the Fed could easily pause its goal to own no MBS if there are problems in the housing market.

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