A senior official from the Federal Reserve made a heavyweight statement for the first time in over half a year! Detailed discussion on the considerations behind reducing QT

On Wednesday, Roberto Perli, an official from the Federal Reserve Bank of New York, stated that slowing down the reduction of the balance sheet by the Federal Reserve is of significant importance. It is believed that the balance sheet reduction can continue to proceed smoothly and orderly. Despite many current indicators showing sufficient reserves, uncertainties regarding the level of reserve adequacy led the Federal Reserve to announce a slowdown in quantitative tightening (QT) on May 1.

Perli pointed out that the Federal Reserve's decision to start slowing down the pace of balance sheet reduction (QT) allows policymakers more time to assess changes in market conditions and the redistribution of liquidity within the banking system:

Two years ago, the Federal Reserve began QT, and since then, the Federal Reserve's balance sheet has been reduced by over $1.5 trillion to $7.4 trillion. However, the uncertainty about the level of bank reserve adequacy makes it reasonable to slow down the pace close to this level.

Although it may not seem significantly different in implementation, slowing down the reduction pace is still an important and cautious step in the balance sheet reduction process. Ultimately, I expect this approach to allow the money market to continue to operate smoothly even when the reserve supply level is lower than originally expected.

Perli acknowledged that the Federal Reserve's key policy benchmark, the effective federal funds rate, remains very stable, and the repurchase agreement market only occasionally experiences funding pressures, typically occurring at the end of the month, end of the quarter, and settlement days for large amounts of U.S. Treasury auctions.

While reverse repurchase agreements (RRP) have absorbed almost all the funds from the Federal Reserve's balance sheet reduction, Perli pointed out that once RRP bottoms out or stabilizes at a lower level, under similar circumstances, bank reserves will start to decline one-to-one as the portfolio shrinks.

At the same time, Perli revealed that policymakers are still monitoring a series of indicators to look for signs related to the adequacy of reserves. These relevant indicators include:

• The spread between the federal funds rate and the interest rate on reserve balances (IORB), currently at negative 7 basis points, which clearly indicates that reserves are still abundant. The interest rate on reserve balances is the rate paid by the Federal Reserve to commercial banks on their deposits at the Federal Reserve.
• The total amount of federal funds borrowing by domestic U.S. banks, which indicates the extent to which they are using the market to meet their funding needs.
• The occurrence of same-day delays in interbank payments, as banks will delay outgoing payments if reserves are insufficient to maintain higher reserve balances for most of the day.
• Daylight overdrafts, which can help determine if banks have enough reserves to handle daily payment activities. When reserves are scarce, the mismatch between outgoing and incoming payments will be more significant.

Last week, the Federal Reserve announced that starting in June, it will slow down QT, with the monthly cap on the reduction of U.S. Treasury holdings decreasing from $600 billion to $250 billion. The reduction of $350 billion exceeds Wall Street's expectation of $300 billion, while the institutional MBS cap remains unchanged at $350 billion The Federal Reserve Bank of New York is the specific operational institution for the Federal Reserve's balance sheet policy. This is the first time since October 2023 that Perli has discussed the Federal Reserve's balance sheet issue in detail.