(March 20): The Federal Reserve (Fed) said it will start shrinking its balance sheet at a slower pace starting next month, reducing the amount of bond holdings it lets roll off every month.

Officials, who left interest rates unchanged on Wednesday, said they will lower the cap starting April 1 on the amount of Treasuries allowed to mature without being reinvested to US$5 billion (RM22.13 billion) from US$25 billion. The Fed will leave the cap on mortgage-backed securities unchanged at US$35 billion.

Chair Jerome Powell said that officials had seen some signs of increased tightness in money markets, a key deliberation for the timing and path of QT, even as reserves remain abundant in the financial system. He also said the decision shouldn’t impact the size of the balance sheet over the medium term.

The central bank has been winding down its holdings since June 2022 — a process known as quantitative tightening, or QT — by gradually increasing the combined amount of Treasuries and mortgage bonds it allowed to run off without being reinvested. It last lowered its monthly cap in June 2024 to US$25 billion from US$60 billion.

The latest decision comes as lawmakers look to strike a deal on the debt ceiling, the statutory limit for outstanding Treasury debt. The US hit that limit in January. Fed governor Christopher Waller was the lone dissenter among officials on the runoff, though he supported leaving interest rates steady.

“Waller’s dissent on QT is notable and suggests some mixed opinions on balance sheet policy,” said Gennadiy Goldberg, the head of US interest rate strategy at TD Securities. “The reason they moved the Treasury QT cap lower to just US$5 billion is so they are able to re-accelerate the pace of runoff after the debt ceiling is resolved. It’s easier to re-accelerate the pace when the cap is already non-zero.”

The longer it takes Congress to either suspend or lift the limit, the more cash that will make its way back into the financial system. That has the potential to artificially boost reserves — currently US$3.46 trillion — masking money-market signals that could indicate when is the right time to stop QT.

It’s those money-market signals that will dictate just how much more the Fed would be able to shrink its US$6.8 trillion portfolio of assets before worrisome cracks start to appear, as they did in 2019 ahead of an acute funding squeeze.

Wall Street strategists had been split on their expectations for the Fed’s balance-sheet plans. For months, officials had said very little publicly about when they might stop reducing the their balance sheet.

Minutes of their January meeting, however, revealed policymakers had discussed the potential need to pause or slow the process until lawmakers can strike a deal over the government’s debt ceiling.

The New York Fed’s Roberto Perli, who oversees the central bank’s securities portfolio, reiterated these concerns during remarks earlier this month.

Uploaded by Siow Chen Ming