NEW YORK (Reuters) -Federal Reserve Governor Christopher Waller said on Thursday the U.S. central bank still has some ways to go in shrinking the size of its holdings, in comments that offered a potential resting size for the ongoing drawdown, while reiterating a case is still there to cut the central bank’s interest rate target later this month.
Given the likely level of bank reserves the financial system needs to be at “ample” levels, Waller said the Fed can likely allow bonds it owns to mature and not be replaced “for some time, reducing reserve balances.” His comments came at an event held by the Dallas Fed.
Against a Fed balance sheet that now stands at $6.7 trillion, with $3.3 trillion in bank reserves, Waller said the ongoing effort to reduce the holdings may have a visible target in view.
Waller said a “hypothetical” Fed balance sheet might stand at $5.8 trillion, with $2.7 trillion in reserves and $780 billion in the Treasury Department’s account with the central bank.
He noted money market turbulence in the fall of 2019 suggests a drop in reserves to below 8% of GDP is an issue, so that metric helped inform his rough estimate of where overall Fed holdings might need to fall.
After more than doubling the size of its balance sheet to a peak of $9 trillion due to COVID-19 era bond purchases, the Fed has over the last three years been steadily shedding Treasury and mortgage bonds as part of a broader normalization of monetary policy.
The Fed aggressively purchased longer-dated Treasury and mortgage bonds during the COVID-19 pandemic and is now seeking to remove much of that excess liquidity, although it is unsure how long this process, known as quantitative tightening, or QT, can run.
Waller has in the past been skeptical of using the Fed’s balance sheet to provide stimulus as it remains unclear how shifts in the central bank’s holdings affect the economy.
SHIFT IN FED HOLDINGS
Waller was speaking a day after the release of the minutes from the Fed’s June 17-18 policy meeting.
The minutes showed that most Fed officials were reluctant to embrace rate cuts amid the likelihood that some form of higher inflation over an uncertain duration lies ahead due to President Donald Trump’s aggressive tariffs policy.
Waller and Fed Vice Chair for Supervision Michelle Bowman recently have flagged an openness to cutting rates at the central bank’s July 29-30 meeting.
Waller believes any inflation increase tied to tariffs will be a one-time event the central bank can look through.
Waller said his interest rate expectations are still in place. When it comes to monetary policy in the current economy, “we’re just too tight and we could consider cutting the policy rate in July.” Waller added, “I’m kind of in the minority on this, but I’ve tried to lay out very clearly, in economic terms, why we could do this.
It’s not political.”
With Waller in the running to potentially succeed Fed Chairman Jerome Powell and President Donald Trump pressing the central bank to cut rates aggressively, the Fed governor’s dovish policy stance has been a matter of debate among many economists and central bank watchers.
The Fed minutes also noted that ahead of the June meeting, big banks and money managers had pushed back modestly their expected end date for the Fed’s balance sheet drawdown to next February.
The banks see Fed holdings falling to $6.2 trillion, with $2.9 trillion in reserves.
In his speech, Waller noted that Fed holdings are skewed toward longer-dated bonds due to the central bank’s bond-buying stimulus efforts.
He said that over time it would likely be a good idea to shift Fed holdings more toward Treasury bills.
Doing this “will be a slow process unless we were to take the dramatic step of selling existing securities to replace them with Treasury bills,” Waller said.
But it could also be the case that the Fed reweights its holdings toward shorter-term securities when the eventual day arrives where it will need to grow its balance sheet again due to the evolution of the broader economy and financial system.
(Reporting by Michael S.
Derby; Editing by Paul Simao and Chizu Nomiyama )
