The Fed’s $6.6 tn test: When to end its portfolio runoff

Three-year bid to shrink asset portfolio comes up against signs of funding pressures in overnight lending markets

- Nick Timiraos

Federal Reserve officials have a suddenly pressing decision when they meet this week that has nothing to do with an interest-rate cut. It is whether to stop shrinking the central bank’s $6.6 trillion asset portfolio within days or wait until the end of the year.

As recently as two weeks ago, the Fed seemed on track for a year-end decision. Fed Chair Jerome Powell, in a rare speech devoted primarily to technical monetary plumbing dynamics, said the central bank could approach the point “in coming months” where it needed to end the three-year-long campaign to shrink its holdings.

But analysts say firmer-than-anticipated pressures in overnight funding markets since then could warrant stopping sooner.

The debate over when to stop portfolio runoff is separate from the one over whether to hold interest rates steady or to cut them, as is widely expected this week. Instead, these deliberations revolve around how best to ensure the Fed maintains effective control over short-term interest rates.

The Fed expanded its enormous portfolio—sometimes called a balance sheet—during the 2007-09 financial crisis and again during the pandemic when it bought colossal quantities of government debt and mortgage-backed securities to stabilize markets and stimulate the economy.

Officials have been gradually shrinking the balance sheet since 2022, when it reached nearly $9 trillion, by letting securities mature without replacing them. When the Fed purchases securities, it creates reserves—electronic cash that banks hold at the central bank. When the securities mature, that electronic money drains out of the financial system.