Federal Reserve to cease reinvestments of maturing securities at the end of the year – Natixis

Analysts at Natixis explain that the minutes of the last Federal Open Market Committee shed new light as to the timing of a possible end in the Federal Reserve’s reinvestment policy.

Key Quotes

“The Federal Reserve is giving serious thought to normalising the size of its balance sheet, which has been stable around $4,500bn since end-2014. Our view, therefore, is that besides a further three hikes in the Fed Funds rate this year, the Federal Reserve will announce a phasing out of reinvestments. This will mark a major turning point, notably for the US Treasury market.”

“Given the sheer amounts involved this will constitute a particularly important development, especially for the US Treasury market. While the proportion of US Treasuries on the New York Fed’s balance sheet is not overwhelming (58% of total assets), it is otherwise when it comes to US Treasuries maturing in 2018 and 2019. With redemptions totalling $428bn and $352bn, respectively, it is almost 32% of the portfolio excluding MBS that will mature by end-2019. For this reason, and since gross funding requirements will remain substantial in the next few years (net requirements put at between $578bn and $676bn by the CBO, combined with TNote/TBond/TIPS and FRN redemptions ranging from $1,700bn to $1,860bn), US long interest rates could face further upward pressures.”

“To slow this potential rise, the Federal Reserve could opt to phase out reinvestments. Federal Reserve Bank of San Francisco President John Williams indicated recently that it may take the Federal Reserve around five years to shrink its balance sheet. If reinvestments cease in January 2018, it will be four years before the balance sheet passes below $3,000bn. For the balance sheet to be of the same size as it was before Lehman’s collapse, it would be necessary to wait until 2045. In other words, unless the Federal Reserve starts reselling its assets, the normalisation of the Federal Reserve’s balance sheet won’t be the big bang that had been expected.”