Citi Economists Predict Federal Reserve Won't Abruptly End Balance Sheet Reduction in September
In a recent note, Citi economists stated that it is unlikely for the Federal Reserve to suddenly announce the end of balance sheet reduction in September or earlier. The Wall Street bank believes that the Fed will pause balance sheet reduction before reserves reach the "somewhat above" ample level, especially in the event of a recession.
During a press conference in July 2023, Fed Chair Powell mentioned that if the economy is stable and the Fed is gradually lowering rates, balance sheet reduction could continue even as policy rates decrease. However, Citi economists suggest that this narrative could change if there is a significant weakening in the labor market and economic activity.
The latest jobs report has revealed more weakness in the labor market than expected, increasing the likelihood that policymakers may hint at the September meeting that the end of balance sheet reduction is approaching, possibly by December. If economic indicators deteriorate further in the coming weeks, a sooner end to balance sheet reduction may be signaled at the September meeting, although an abrupt end in September is not the base case unless there are acute liquidity issues.
With reserves still at abundant levels, reverse repo balances around $290 billion, and the standing repo facility as a safety net, major liquidity pressures are not expected in the coming months. The Fed's balance sheet saw a reduction of approximately $27 billion in the week ending July 31, with reductions in both Treasuries and mortgage-backed securities.
The Treasury's cash account surged to $854 billion on July 31 due to month-end settlements but has since decreased to $759 billion. Reverse repo balances have remained high despite rising SOFR rates, potentially due to counterparty limit issues. Bank reserves fell to $3.178 trillion from $3.276 trillion during the same week, reflecting the strong TGA liquidity.
In conclusion, the Federal Reserve is unlikely to end balance sheet reduction abruptly in September, according to Citi economists. The latest economic indicators suggest that policymakers may signal the nearing end of balance sheet reduction at the September meeting. This could have implications for the financial markets and investors, as it may impact interest rates and liquidity levels. It is important for individuals to stay informed about these developments and consider how they may affect their financial decisions.