USD/CAD Rebound Unravels as Fed Balance Sheet Approaches Record High (2024)

FAQs

What happens when the Fed unwind its balance sheet? ›

Meanwhile, when the Fed shrinks its balance sheet, it doesn't turn around and sell those assets. Instead, it lets those assets roll off at maturity, refraining from reinvesting its proceeds. When the Fed redeems its securities holdings, the overall size of its balance sheet shrinks — and so do banks' reserves.

The Fed can reduce its balance sheet by electing not to reinvest some or all of the principal repaid when securities mature, a practice known as runoff. The Fed can also sell securities ahead of the maturity date. Fed balance sheet reductions reflect economic gains that are partly from previous Fed asset purchases.

When the Fed wants to increase the amount of currency in circulation, it buys Treasurys or other assets on the market. When it wants to reduce the amount of currency in circulation, it sells the assets. The Fed can also affect the money supply in other ways, by lending money at higher or lower interest rates.

After doubling the size of the balance sheet to about $9 trillion from its pre-pandemic size, the Fed has been allowing some of its holdings of Treasuries and mortgage-backed bonds to expire. That process, started in the latter half of 2022, has seen the Fed's balance sheet fall to $7.5 trillion.

Even as the Fed has begun to scale back its holdings, it held nearly $6.1 trillion in government bonds – almost a fifth of the entire public debt – as of Sept. 30, 2022, the most recent data available. A decade earlier, by contrast, the Fed's share of the debt was just under 11%.

The Federal Reserve's balance sheet. The Federal Reserve operates with a sizable balance sheet that includes a large number of distinct assets and liabilities. The Federal Reserve's balance sheet contains a great deal of information about the scale and scope of its operations.

As part of the post- crisis normalization of monetary policy, the Fed began to reduce the size of its balance sheet in June 2022—to date, by more than $1.5 trillion (or 18%) from its peak size. The Fed's balance sheet can be described in standard accounting terms.

Banks have little incentive to maintain excess reserves because cash earns no return and may even lose value over time due to inflation. Thus, banks normally minimize their excess reserves, lending the money to clients rather than holding it in their vaults.

It began reducing its balance sheet gradually (known as quantitative tightening, or QT) in June 2022 by not reinvesting all the proceeds of maturing securities. As of the end of March 2024, the Fed had reduced its assets from a peak of nearly $9 trillion to $7.4 trillion.

The major items on the liability side of the Federal Reserve balance sheet are Federal Reserve notes (U.S. paper currency) and the deposits that thousands of depository institutions, the U.S. Treasury, and others hold in accounts at the Federal Reserve Banks.

Who prints money in the United States? ›

U.S currency is produced by the Bureau of Engraving and Printing and U.S. coins are produced by the U.S. Mint. Both organizations are bureaus of the U.S. Department of the Treasury.

Today, the Fed is tasked with managing U.S. monetary policy, regulating bank holding companies and other member banks, and monitoring systemic risk in the financial system. The seven-member Board of Governors, the system's seat of power, is based in Washington, DC, and currently led by Fed Chair Jerome Powell.

QE May Cause Inflation

The biggest danger of quantitative easing is the risk of inflation.

The Federal Reserve could also sell securities, but that is more rare. Since the beginning of last year, the Fed has been purchasing fewer securities than are maturing, thereby reducing its balance sheet. This process is called “unwinding,” and it's a strategy the Fed uses to keep the economy from overheating.

If the Fed's balance sheet were to continue to grow, it could, in theory, run out of Treasuries or other acceptable assets to purchase to conduct QE in the future.

When the Fed first begins to shrink its balance sheet, reserves will still be well above what banks require. But as the total supply of reserves shrinks, each additional dollar of reserves drained will have a greater effect on interest rates.

As signs of economic recovery emerge and inflationary pressures rise, the central bank may consider reducing asset purchases, aka shrinking the balance sheet. This typically means gradually decreasing monthly asset purchases until they halt or slow down.

Tapering is the gradual slowing of the pace of the Federal Reserve's large-scale asset purchases. Tapering does not refer to an outright reduction of the Fed's balance sheet, only to a reduction in the pace of its expansion.

The FOMC established caps on the monthly pace of runoff; specifically, since September 2022, three months after balance sheet reduction began, those caps have been $60 billion for Treasury securities and $35 billion for agency debt and agency MBS.