The secret’s out. The Fed wants to shrink the size of its balance sheet, and they want to begin the process sometime this year. What does this mean for investors? And what does it mean for key variables such as interest rates, inflation, and economic growth? Let’s find out.
For those who may not recall, in the midst of the financial crisis, the Fed embarked on a bond-buying spree known as quantitative easing. This process involved the purchase of trillions of dollars’ worth of long-term Treasuries and mortgage-backed securities in an attempt to 1) suppress long-term rates, 2) inject liquidity into the financial system and 3) remove toxic assets from the balance sheets of public and private institutions.
Quantitative easing was phased out in 2014 but has left the Federal Reserve holding a massive $4.5 trillion balance sheet. This portfolio of bonds has remained steady in recent years as the Fed continues to roll over maturing Treasuries and reinvest the principal payments from the mortgage-backed securities.
In a recent commentary, the Fed has made it clear that it now wishes to begin the ‘unwinding’ of its balance sheet, effectively relinquishing most of these assets back into the marketplace. This process has been dubbed ‘quantitative tightening,’ and will represent another foray by the Federal Reserve into uncharted monetary waters.
This post was published at FinancialSense on 05/31/2017.