Fed thinking about growing balance sheet again: K.C. Fed paper

(Reuters) – The Federal Reserve is considering when to halt the decline in bank reserves and start growing its balance sheet again, according to a paper from the Kansas City Fed released on Wednesday.

Reserve balances of $1.5 trillion could be needed if policymakers operate as of now with a near-zero spread between two bank borrowing rates — the federal funds rate and the interest rate the Fed pays on reserves — according to the research by Kansas City Fed Senior Economist A. Lee Smith. That would be a relatively small decline from less than $1.7 trillion now.

Along with its rate-hike holiday, Fed policymakers are finalizing plans on how they would end the reduction of their balance sheet, which includes holdings of bank reserves bulked up in part by the Fed’s need for cash to buy bonds to halt the global financial crisis a decade ago.

The “effective” or average fed funds rate has been running at 2.40 percent since mid-December, which is at parity with the interest rate on reserves.

Fed Chair Jerome Powell said last month that the Fed will stop shrinking its $4 trillion balance sheet later this year, ending a process that investors say works at cross-purposes with the Fed’s current pause on interest-rate hikes.

To this point the Fed has mostly been citing external estimates of what level of reserves would be needed.

GRAPHIC-U.S. federal funds activity: https://tmsnrt.rs/2EcJkRq

GRAPHIC-U.S. federal funds activity interactive: https://tmsnrt.rs/2EdOEUF

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