Bartsch said quantitative easing may not have been the booster to risk assets that many thought it was. But it may have helped the Fed communicate that it would keep rates low, because as long as it was buying assets, it was not raising rates. Bartsch said the wind down is much more telegraphed to the market than the start of easing, which was expected to affect financial markets.
Now there are doubts the Fed will be able to continue scaling back its balance sheet as much as previously thought. Powell has said the Fed this fall will review the balance sheet, which is still at about $4.2 billion.
“I would not expect to hear any policy action on the balance sheet wind down just yet but more the framework on how they think about it,” said Bartsch.
In part due to new rules for bank capital, banks are keeping much more of their cash at the Fed than they used to. This has resulted in a higher interest rate on excess reserves, and has driven that rate closer to the fed funds rate, the short-term rate the Fed influences with its target range.
“There are no transaction costs associated with it. Right now, they receive a relatively attractive rate of return versus other alternatives, and I think they see this as the cleanest means with which they can meet their regulatory guidance,” said Cabana.
The interest on excess reserves, or [IOER] is now 3 basis points above the fed funds rate, compared to an average spread over the past five years of 12 basis points, Cabana said.
Strategists said the Fed will likely decide on what to do about its balance sheet program sometime next year.
Bartsch said concerns about the Fed’s policy unwinding are overblown and that the market shouldn’t see it as merely the reversal of quantitative easing.
“It is a very different context in which it happens,” she said. “Back when quantitative easing started, we had severe balance sheet stress in many private financial institutions…The Fed’s balance sheet was the only one growing that was able to grow in a meaningful way.”
Bartsch said the tools the Fed has used for the crisis will not go away, and they could be used in the future if needed.
“This was a once in a generation financial crisis., and a once in a generation global recession,” she said. “Very specific situations created in the process takes some time..I know that people talk about central bank normalization…. if it was normal, why did we have the financial crisis?”
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