The Federal Reserve will soon shrink its balance sheet to the tune of $95 billion per month, ramping up to that pace over three months, newly released minutes from the March 15-16 meeting indicate. After release of the Fed meeting minutes, the Nasdaq remained solidly lower as growth stocks continued to bear the brunt of a surge in long-term Treasury yields.
Federal Reserve Balance-Sheet Plan
The Fed will set monthly caps for shrinking its balance sheet as bonds mature, rather than reinvesting the principal. The minutes said that committee "participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS (mortgage backed securities) would likely be appropriate."
Those caps could be phased in over a period of three months, or perhaps modestly longer, the minutes said.
With a policy announcement expected as soon as the May 3-4 meeting, that could mean the $95 billion monthly cap could apply as soon as July.
The Federal Reserve said its holdings of short-term Treasury bills would be redeemed so that reductions of Treasury holdings will meet the monthly caps. However, MBS redemptions may come in shy of the cap, since they are partly a function of prepayments, such as when someone refinances.
Yet after balance-sheet runoff is "well underway," policymakers said they will consider outright sales of the Fed's mortgage holdings.
Nasdaq, Treasury Yields React To Fed Meeting Minutes
The extent to which the Fed sees balance-sheet tightening as part of a one-two punch in fighting inflation caught Wall Street somewhat off-guard on Tuesday. In a speech, Fed Gov. Lael Brainard, who is President Joe Biden's nominee to serve as Fed vice chair and is among the more dovish policy committee members, called it "of paramount importance to get inflation down."
"Accordingly, the committee will continue tightening monetary policy methodically through a series of interest-rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting," Brainard said.
Her comments sparked a stock market sell-off on Tuesday, with the Nasdaq sinking 2.3%, while the S&P 500 lost 1.3% and the Dow Jones shed 0.8%. The selling came as the 10-year Treasury yield shot up 14 basis points to a three-year-high of 2.56%, then pushed still higher on Wednesday, rising to around 2.61%.
Stocks continued to sink on Wednesday, with the Nasdaq tumbling 2.2%. The S&P was off 1% and the Dow Jones was down 0.4%.
Fed Fears Continue To Slam Techs; These Giants Make Key Moves
Impact Of Balance-Sheet Tightening
From the start of the pandemic through March, the Federal Reserve purchased about $4.5 trillion in Treasuries and government-backed mortgage securities. That roughly doubled the Fed's balance sheet.
The asset purchases, also known as quantitative easing, enable the Fed to ease monetary policy even when its benchmark interest rate is at zero. Buying those safe assets brings down interest rates, which promotes risk-taking in several ways. It lowers the return on safe assets. That provides a boost to growth-stock valuations, by raising the present value of future cash flows based on a lower 10-year Treasury rate.
Finally, Federal Reserve purchases provide a liquidity boost by freeing up funds that had been parked in safe Treasuries and mortgage securities.
Now, all of those impacts are set to begin reversing, which will create a headwind for stocks, and especially the growth stocks that heavily populate the Nasdaq.
