By Michael S. Derby
NEW YORK (Reuters) -Federal Reserve Bank of Cleveland President Beth Hammack said on Wednesday conditions still support ongoing reductions in the central bank’s balance sheet, adding she believes some active management of market liquidity via Fed interventions is acceptable to her.
“We still appear to have more than enough reserves in the system so that active management isn’t needed,” Hammack said in the text of a speech prepared for delivery in New York before a meeting of the Money Marketeers of New York University. She did not comment on the economic outlook in her prepared remarks.
With more room to run on shrinking Fed holdings — the process widely referred to as quantitative tightening, or QT – Hammack said that as she sees it, keeping Fed holdings too large comes with risks for financial stability.
“To the extent that a large balance sheet with more-than-ample reserves dampens money market volatility, it also promotes risk-taking in financial markets,” she said.
Hammack also said that over time, temporary market interventions by the Fed to manage short-term swings in volatility could be warranted.
“There may be scenarios in which the Federal Reserve would need to add temporary liquidity,” she said, noting “in that case, nothing would prevent” the New York Fed “from using its standard tools of open market operations to maintain the fed funds target range even if reserves were ample.”
Hammack tackled the outlook for the central bank’s balance sheet after it decided last month to substantially slow the ongoing drawdown of its holdings of Treasury and mortgage bonds. Since 2022 the Fed has been allowing bonds it owns to mature and not be replaced. It has twice slowed the pace of that contraction to better allow policymakers to ensure they are not pulling out liquidity too swiftly.
Hammack said in her speech she supported the slower drawdowns. While there were still enough reserves in the system to press forward, “I expect that by slowing the pace of runoff, we will be able to let the process continue for longer,” she noted.
“I interpret this slower pace to emphatically not be a signal of a permanently larger balance sheet than would have been the case without a slowdown.”
Via QT, the Fed has been withdrawing money it added during the COVID-19 pandemic and its aftermath. Bond purchases aimed at stabilizing markets and providing stimulus more than doubled the size of Fed holdings to $9 trillion, and the contraction process has brought the balance sheet down to $6.8 trillion.
It is unclear how far the Fed will be able to shrink its holdings, as it works toward a landscape where there is enough liquidity to allow for normal market volatility and for the Fed to retain firm control over its short-term interest rate target.
Fed officials believe the newly reduced pace of drawdown will allow QT to reach its natural endpoint without creating market disruptions.
Comments from Hammack ahead of the March Federal Open Market Committee meeting suggest the policy maker would have preferred another path for the balance sheet. In a February Reuters interview, she noted her desire for a steady QT pace and the use of repo operations to deal with any liquidity needs the market might have around market volatility tied to government efforts to manage its cash.
Focus on the Fed balance sheet has been renewed amid high levels of market volatility tied to the twists and turns of President Donald Trump’s tariff regime. Stress has been such that some have wondered if the Fed might have to intervene with market-stabilizing bond purchases if trading became truly disordered.
(Reporting by Michael S. Derby; Editing by Richard Chang)
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