WASHINGTON — The Federal Reserve could continue shedding mortgage-backed securities even once it stops shrinking its balance sheet.
During its meeting Wednesday afternoon, the Federal Open Market Committee voted to slow the pace of its balance sheet reduction by up to $20 billion per month. During his post-meeting press conference, Fed Chair Jerome Powell floated the idea of continuing to allow its MBS holdings to shrink after it finishes quantitative tightening.
"We want the MBS to roll off our balance sheet," Powell said. "We strongly want that, but we haven't made any decisions about that yet."
The FOMC's decision to lower the monthly cap on its Treasury securities runoff from $25 billion to $5 billion was not unanimous. Fed Gov. Christopher Waller voted against the Fed's policy action at the meeting — which also included keeping the federal funds rate between 4.25% and 4.5% — preferring to see the runoff rate remain unchanged.
Meanwhile, the Fed kept the cap on MBS runoff unchanged at $35 billion per month.
The Fed has signaled in the past that it might like to rid its balance sheet of mortgage-backed securities at some point, but Powell's statement Wednesday made clear that the committee considers that an objective of the current QT cycle.
During the press conference, Powell said the idea of adjusting its balance sheet runoff first came across the FOMC's radar as the debt ceiling negotiations in Congress caused funds to flow significantly in and out of the Treasury's General Account, which is represented as a liability on the central bank's books.
Changes in the TGA can impact other Fed liabilities, such as reserves, or funds held by commercial banks at the Fed. Powell has said repeatedly that the Fed wants to stop QT before it results in reserve scarcity — an outcome that could make it harder for banks to transact with one another and manage their own liquidity supplies, while also disrupting the transmission of monetary policy.
Powell said the committee considered pausing QT, but ultimately decided that a slowdown would be more appropriate, as it will allow the wind down process to carry on longer.
"If you're cutting the pace of QT in half, the runway is roughly doubled, it's lower for longer and people really liked that," he said. "It's like a plane coming in for a landing."
Because of this, Powell said the change will have no impact on the ultimate size of the Fed's balance sheet at the end of QT, nor should it be seen as having "a signal that in any way you can tease out," regarding the Fed's monetary policy.
Balance sheet adjustments typically have an indirect impact on longer-term interest rates, but the belief is that when the balance sheet is contracting, that change is factored into market expectations quickly on a one-time basis.
This is the second time the Fed has slowed the pace of balance sheet reduction. Powell said the process for slowing QT is playing out as the FOMC said it would, noting that it will come to an end slightly before reserves become scarce.
But, even once that overall reduction ends, Powell said, the Fed can continue allowing its MBS holdings to mature and replacing them with Treasuries instead of new MBS.
Powell makes no commitments
If banks and financial market participants are looking for a clear signal through the noise of recent economic uncertainty, they are not alone. Powell said the Fed is right there with them.
The theme of this week's meeting and press conference was how policy and market developments are making it difficult for the FOMC to set firm expectations on which to set monetary policy. During his press conference, Powell was careful to avoid making any overt predictions or commitments.
He did note that inflation expectations, both from consumers and businesses, are elevated in the short term but moderate next year and the year after, readings that he said bolstered the committee's decision to hold rates steady and leave their own forecasts relatively unchanged.
"You do see increases widely in short-term inflation expectations, and people who fill out surveys … are pointing to tariffs [as the source of] that," Powell said. "If you look a little further out, you don't see much in the way of an increase in long-term inflation expectations. We will be watching all of that very carefully. We do not take anything for granted. But that's what you see right now."
In the quarterly summary of economic projections, all 19 FOMC participants wrote down the expectations for inflation, unemployment, economic growth and interest rates through the end of this year as well as through 2025, 2026 and over the longer term. The average interest rate expectation was unchanged from December at 3.9%, but the distribution of predictions was noticeably different.
Eleven participants said they expect to cut rates at least two times this year, down from 14 who projected that many during the last quarterly survey in December. Meanwhile, four officials called for no cuts this year, up from one three months ago.
Powell said that the combination of slower economic growth and higher inflation expectations "cancel each other out" in the eyes of participants, which explains why overall expectations are unchanged.
Are tariffs transitory? Fed thinks so
Powell said it's too soon for the Fed to attribute any changes in economic conditions to the Trump administration. He said the central bank is looking at four categories of policies — trade, immigration, fiscal and immigration — to understand how the new government is likely to influence inflation. He noted that the Fed will focus on the cumulative impact of all four.
Thus far, Powell said it is clear that the anticipation of tariffs is clearly contributing to overall inflation, but it is very difficult to determine to what extent.
For now, he said, the FOMC is treating tariffs as a one-time increase to the level of prices, rather than something that will drive excessive price growth on an ongoing basis. In other words, it will be transitory.
"That's the base case, but we really can't know that … we need to see how things work out," Powell said.
