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Friday, 08 February 2019 13:00

Fed's balance sheet still likely to shrink through 2020

Fed's balance sheet still likely to shrink through 2020

The size of the Federal Reserve's balance sheet is likely to continue falling through 2020 despite the Federal Open Market Committee's (FOMC) new forward guidance on balance-sheet normalization, Caspian Energy News (www.caspianenergy.net) reports with reference to Fitch Ratings.

The decline in the Fed's balance sheet from current levels will be smaller than Fitch previously forecast, but given that the ECB has ended quantitative easing (QE) purchases and the Bank of Japan is tapering its balance-sheet expansion, global quantitative tightening is here to stay.

According to Fed Chairman Jerome Powell, the Fed would maintain the 'floor' system for setting interest rates indefinitely. This has implications for the long-run size of the balance sheet because the floor system (which since 2008 has set an administratively determined interest rate by paying banks the policy interest rate on their reserve balances at the Fed) requires the Fed to provide the banking system with sufficient reserves to saturate demands for overnight liquidity. Without abundant overnight liquidity, banks could bid for overnight funds in the interbank market, driving interest rates above the policy rate.

Under its pre-2008 framework, the Fed did not pay interest on reserves and controlled rates indirectly by maintaining reserves at very low levels and varying reserve supply daily. This kept the market clearing price of overnight liquidity in line with the Fed funds target policy rate.

The fresh commitment to the floor system elevates the importance of regulatory changes that have sharply increased US banks' demand for overnight liquidity. Banks must now hold high-quality liquid assets (HQLA) - which include reserves at the Fed - to meet minimum liquidity coverage ratios.

More details: https://www.fitchratings.com/site/pr/10061546

Person in charge of the newsline: Olga Nagiyeva 

 

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