New York Fed sees 3-year balance sheet crash to $5.9 trillion, MBS slow decline amid no sales

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A man walks in front of the Federal Reserve Bank of New York in New York, U.S., October 12, 2021. REUTERS/Brendan McDermid

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WASHINGTON, May 24 (Reuters) – The Fed’s stock of Treasuries and mortgage-backed securities is expected to decline by about $2.5 trillion by mid-2025, to about $5.9 trillion. dollars, when the liquidation of central bank assets is likely to be halted. maintain an adequate level of bank reserves, the New York Fed announced on Tuesday.

But that run-off won’t do much to shrink the most controversial part of the Fed’s portfolio, the $2.7 trillion in mortgage-backed securities it currently holds. According to New York Fed projections, the share of assets held in MBS would remain roughly constant through 2025, with the central bank still holding about $1 trillion of these securities by 2030.

The Fed wants to pull its holdings out of the mortgage market altogether, and the expected slowness in MBS has prompted some policymakers to call for an outright sale of these securities.

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The New York Fed’s annual report on its open market operations provides key insight into how the Fed’s holdings, which soared to nearly $9 trillion during the pandemic as it bought assets to stabilize major financial markets, will evolve now that the Fed lets its balance sheet shrink.

Monthly declines will be around $80 billion through 2024, according to New York Fed estimates.

The decline will continue for about three years, the New York Fed said, at which time Fed holdings could be held constant at about 22% of gross domestic product and then rise again in line with the economy.

Reserves required by the banking system are included in this amount, which the New York Fed has estimated at around 8% of gross domestic product.

The report also highlighted the risks associated with the Fed’s transition to a smaller balance sheet at a time of rising interest rates. One of the Fed’s tools for raising short-term market interest rates is to pay more for reserve deposits held by banks with the Fed. As that spending increases, the Fed’s reduction in its own holdings means it will earn less in interest payments on its Treasury bills and mortgage-backed securities.

Under current Fed projections, “net income is expected to decline significantly,” the New York Fed said, meaning smaller profits will flow back to the US Treasury.

If rates rise even faster, the Fed could, for a while at least, operate at a loss, effectively forced to print money to pay its bills and completely halt remittances to the Treasury. Fed remittances in 2021 were over $100 billion.

Since the market price of securities falls when yields rise, higher interest rates also mean that the market value of the Fed’s portfolio has fallen and next year could on paper be worth around 300 billions of dollars less than its face value.

Fed officials acknowledged that if they chose to sell MBS in a higher interest rate environment, they could suffer losses. Their cash investments are, however, intended to be held until maturity, when the full face value is repaid.

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Reporting by Howard Schneider Editing by Chizu Nomiyama and Nick Zieminski

Our standards: The Thomson Reuters Trust Principles.

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