US Fed to reduce monthly redemption cap on Treasury securities to $5 billion: How will this impact investors?

The Federal Reserve said on Wednesday that starting next month it will slow the pace of its balance sheet drawdown amid an ongoing impasse over lifting the government’s borrowing limit, a shift that will likely hold for the remainder of the process.

The announcement came as part of a Federal Open Market Committee meeting that left the central bank’s interest rate target unchanged, as officials deal with considerable uncertainty and a souring public mood around the economic outlook tied to aggressive and often chaotic policy changes by the Trump administration.

The shift on the balance sheet had been hinted at in the meeting minutes for the January FOMC meeting, released last month. Fed Governor Christopher Waller, who has at times been at odds with his colleagues over the management of the central bank’s stock of cash and bonds, dissented against the shift in the balance sheet drawdown.

The Fed said that as part of the reduction in the pace of quantitative tightening, or QT, the monthly cap of Treasuries that will be allowed to mature and not be replaced will be ratcheted down to $5 billion per month from the prior $25 billion monthly cap, effective on April 1.

The mortgage-backed securities cap will hold steady at the current $35 billion limit.

Ahead of the Fed meeting, a number of banks had expected some sort of change in QT given the guidance of the minutes. But most who saw a shift also expected it to be temporary given that the minutes had tied the situation to presumably temporary government cash management issues.

However, Fed Chair Jerome Powell, speaking in a press conference after the FOMC meeting, strongly indicated the slower pace of the drawdown would not change and would also help lead to a smoother end to QT.

Fed officials “came to be pretty strongly in favor of this move” which may also extend how far the central bank can run QT before needing to stop, Powell said.

Some market participants viewed the slowdown in QT, resting almost entirely on Treasuries, as a soft form of a complete stop.

The change is “big news,” said ING’s Chief International Economist James Knightley, in a note. “It’s not clear why the Fed did not just decide to go to zero, apart from not giving the market the news story that the QT in Treasuries was fully over,” he said, noting that this is the second down shift in QT and that the monthly drawdown for Treasuries had been until last May at $60 billion per month.

Powell was asked in the press conference why the Fed had not also slowed the drawdown pace for mortgage-backed securities and noted that may happen one day. Throughout the QT effort, the Fed has struggled to reach the cap for that type of security due to conditions in the housing market where mortgage creation has been very slow and refinancing activity light amid a shift higher in rates.

The Fed’s QT process has been running since 2022 and has been designed to strip from the financial system liquidity added during the COVID-19 pandemic and its immediate aftermath. To stabilize the financial system and provide stimulus, the Fed bought Treasury and mortgage bonds aggressively, more than doubling the size of its holding to a peak of $9 trillion.

QT has thus far helped the Fed shed just over $2 trillion from its balance sheet. Comments from Fed officials have suggested that all else being equal, the financial system still has enough excess liquidity sloshing around that QT has some distance left to go.