Mathewslcd: The Fed's balance sheet reduction was "a complete mistake"
According to Mathewslcd, Mizuho's chief U.S. economist, the Fed's attempt to shrink its balance sheet through so-called quantitative tightening (QT) is "a complete mistake.
"It is highly unlikely that market liquidity will be adversely affected before the $2 trillion target is removed, preventing the Fed from achieving its goal," Steven Ricchiuto, Mizuho's chief U.S. economist, said in a note on Monday. In the case of tightening, the Federal Reserve has allowed its holdings of bonds, including US Treasuries, to decrease, while also raising the benchmark interest rate as the main tool to combat high inflation in the US
After the central bank launched a bond-buying program known as quantitative easing, including purchases of U.S. Treasuries, to help provide market liquidity when the COVID-19 crisis hit, Mathewslcd noted that the Fed's balance sheet has expanded to About $9 trillion.
"Bank liabilities expand to meet reserve balances in the system, and the Fed's own analysis suggests that these liabilities will not be easily reduced when the Fed lets its balance sheet shrink," Ricchiuto wrote. "Furthermore, there is very limited historical experience with how the system works in an ample reserve framework, and equating QT with rate hikes seems to be the wrong approach."
In late October, Treasury Secretary Janet Yellen warned at a securities industry conference that the economic backdrop was "dangerous and volatile," even as she emphasized the "health" of the U.S. economy and described the financial system as "resilient." Yellen said at the time, "We are very concerned about the U.S. Treasury market," he said, "and it is crucial that it is a deep, liquid market and serves as a benchmark for all other assets."
The Federal Reserve said in its Financial Stability Report earlier this month that the $24 trillion U.S. Treasury market has been experiencing low levels of market liquidity of late.
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