The U.S. central bank faces no imminent pressure to stop the contraction of its holdings of Treasury bonds and mortgage-backed securities, data released by the New York Federal Reserve suggested on Thursday.
The regional Fed bank reported that its recently launched Reserve Demand Elasticity measure essentially held steady as of Jan. 7 at -0.04 relative to recent readings and said “the estimate suggests that reserves remain abundant.”
For the Fed, an abundant reserve level means that liquidity in the financial system remains strong enough that it can continue to shrink its balance sheet by allowing some of the Treasury and mortgage bonds it owns to mature and not be replaced.
This process, which began in 2022, is called quantitative tightening, or QT, and it has allowed Fed holdings to go from a peak of about $9 trillion in the summer of 2022 to the current level of just under $7 trillion.
Fed officials have been uncertain how much further they’ll be able to cut the holdings. But seeking to avoid a replay of the events of the fall of 2019, when the last chapter of QT unexpectedly withdrew too much liquidity and forced central bank interventions, they have taken lessons from that episode.
The Reserve Demand Elasticity measure helps measure liquidity conditions and appears to front-run shortages with robust lead times. The Fed has also slowed the pace of the QT drawdown and also put in place a facility called the Standing Repo Facility, which provides fast cash to eligible banks, in a bid to quickly address any market kinks.
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