Fed likely to keep a $6.8 trillion balance sheet by December, says Barclays

 Another lasting facet of the pandemic looks to be a very large Federal Reserve balance sheet.

The Fed's balance sheet grew to a record size of nearly $9 trillion during the COVID crisis as it looked to shore up financial markets with liquidity.

Now, the central bank looks likely to stop shrinking its footprint in financial markets to about the $6.8 trillion mark before year-end, according to Joseph Abate, a U.S. rates strategist at Barclays.

"We look for the Fed to end QT in December," Abate wrote, in a Monday client note, using the short hand for "quantitative tightening," or the process of reducing the central bank's balance sheet as maturing bonds roll off, without proceeds being reinvested.

Its current size is about $7.3 trillion, with the Fed in May announcing plans to dial back how much its balance sheet shrinks each month, beginning in June, by letting up to $25 billion of maturing Treasury securities roll off each month, instead of the previous $60 billion cap.

The Fed also in June will start reinvesting proceeds from its maturing mortgage-backed securities (MBS) holdings, above its $35 billion monthly roll-off cap, into Treasurys.

The Fed and federal government both have drawn fire for their bazooka of pandemic-era support for households and the economy, including as asset bubbles formed and inflation surged to its highest level in four decades.

The Fed in 2022 responded with aggressive interest-rate hikes, which helped cool inflation, even though some aspects, like gas and shelter costs, remain higher than expected. As a result, the Fed has resisted lowering its policy rate from the current 5.25% to 5.5% range since last summer.

But despite higher rates, U.S. stock benchmarks have shrugged off pockets of weakness to return to record highs, with the Dow Jones Industrial Average DJIA last week crossing the 40,000 mark for the first time and the S&P 500 SPX holding above 5,300, fueled by optimism around corporate earnings, a soft economic landing and the Fed's ability to avoid overkill in tightening financial conditions.

"Fed caution and uncertainty about banks' demand for reserves argues for ending QT with still ample reserves," Abate said, pointing to concerns around triggering a repeat of the 2019 reserves turmoil that briefly led short-term lending rates to spike almost 10%.

Still, with the Fed owning more than 30% of the world's outstanding supply of 10-year Treasurys, BX:TMUBMUSD10Y BlackRock sees reason for worry in the months ahead, especially if the central bank opts to significantly change the makeup of its balance sheet to include more shorter-dated assets.

https://www.morningstar.com/news/marketwatch/20240520121/fed-likely-to-keep-a-68-trillion-balance-sheet-by-december-says-barclays