Coming in earlier than many expected, the Fed for the first time laid out how it plans to "normalize" its balance sheet which it expects to reduce by trimming reinvestments in TSYs at a rate of $6Bn/month initially, and MBS at $4Bn/month, or a total of $10bn/month, and will increase the reinvestment caps in steps of 10bn at 3 month intervals over 12 months until it reaches a total 50bn per month. Indicatively this is well below Goldman's expectation of $10bn and $5bn initial caps for TSYs and MBS, as we showed over the weekend...
As its said in the addendum to the materials, “the Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated” with directions to read a Policy Addendum.
As the Fed further explains, the reinvestment cap will hit TSYs at the tune of $6Bn per month initially, and MBS at $4Bn:
for payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be USD6bn per month initially and will increase in steps of USD6bn at 3m intervals over 12m until it reaches 30bn per month.
For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.
This level of detail provided is the main surprise so far and what traders are most focused on, because as Citi notes, it as moving forward the chances for a balance sheet announcement from December. More questions on how soon implementation would follow.
Commenting on the Fed's unwind schedule, BMO's Ian Lyngen writes that the Fed positions itself for September/December tapering. It notes that the Fed’s reinvestment tapering plan sets up the central bank to begin unwinding its balance sheet at either the September or December meeting. If the Fed reaches the maximum $30b/month cap for Treasuries (with a December start), this means $325b of UST tapering in 2018, amounting to “roughly half of a 25bp rate hike,” BMO says, using recent Fed estimates
Indicatively, this is the significantly higher reinvestment cap schedule that Goldman expected earlier:
# Process for phasing out reinvestment: The May minutes signaled that the committee will preannounce a schedule of gradually increasing caps to limit the amounts of securities that can run off in any given month. Our assumption is that that the initial caps are $10 billion a month for UST and $5 billion a month for MBS. The caps would rise each quarter by $10 billion and $5 billion to $40 billion and $20 billion respectively. Caps allow for a gradual runoff and deal with the variability associated with MBS prepayment and the irregular monthly schedule of maturing assets. The caps will remain in place after the phase-in but then only bind in roughly a third of the months for Treasuries until mid-2020 when the balance sheet reaches its projected terminal size....