By By Michael S. Derby
NEW YORK (Reuters) – The official responsible for managing the Federal Reserve’s massive holdings of cash and bonds said on Thursday there’s likely plenty of room left to run in shrinking the central bank balance sheet.
“For now, pressures in the repo market don’t appear to be close to the point where they would start affecting the federal funds rate,” said Roberto Perli, manager of the Fed’s System Open Market Account, in a speech text for a New York Fed conference. “For that reason, I believe there is plenty of room to continue shrinking” Fed holdings, which now stand at about $7.2 trillion, he said.
Perli’s comments on the state of central bank holdings come as the Fed this summer passed the two-year mark of trying to shrink the size of its holdings after rapidly increasing them starting in the spring of 2020. The Fed aggressively bought Treasury and mortgage securities to calm markets and stimulate the economy, more than doubling the size of its holdings to $9 trillion.
Over the last couple of years the Fed has been allowing some of its bonds to mature and not be replaced. It is seeking to draw out pandemic-era liquidity and leave market liquidity at a level that can allow for normal money market rate volatility and firm central bank control over short-term rates.
Fed officials are unsure how far they’ll have to go with the effort and are watching markets for clues liquidity is getting tight. Despite embarking on a campaign of rate cuts Fed Chair Jerome Powell said last week the Fed plans to press forward with the balance sheet drawdown.
In his remarks, Perli noted that market repo rates have been rising but this may not be a sign liquidity is growing tight. One challenge for the repo market appears to owe to “frictions that have developed in the market that are interfering with the liquidity redistribution process. One example of such frictions stems from increased concentration in the repo market” which make it harder for firms to trade with one another.
Repo market friction “has manifested itself fairly clearly in substantial remaining balances” at the New York Fed’s reverse repo facility even when private sector market investments offer better rates, Perli said.