U.S. Fed likely to announce start of balance sheet normalisation next week

The U.S. Fed is expected to announce the beginning of its balance sheet normalisation during its FOMC meeting that is set to take place next week. According to Nordea Bank, no major changes are expected. The central bank is likely to hike one more time this year.

The announcement of the monetary policy normalization process will start to permit maturing Treasuries and mortgage-backed securities to run off its balance sheet, contrary to the current practice of reinvesting all of the proceeds.

Several Fed officials have hinted in recent speeches and interviews that they are prepared to announce during next week’s meeting that in October they would gradually start shrinking the central bank’s USD 4.5 trillion balance sheet – before the Fed leadership changes start in earnest.

The central bank is expected to keep interest rates on hold during its meet. According to the Fed’s plan, it would decrease reinvestments in an orderly and well-communicated way, with repayments reinvested only to the degree they exceed gradually rising caps. Consistent with the Fed’s guidance, an initial cap of USD 10 billion per month is expected, rising by USD 10 billion every three months until it reaches USD 50 billion in October 2018, stated Nordea Bank.

The balance sheet adjustment is expected to continue for several years. According to New York Fed staff projections, the Fed’s security holdings, which currently stand at USD 4.2 trillion are expected to shrink by around USD 1.5 to 2 trillion in the next four to five years. This would lower the size of the Fed’s balance sheet to a level that is appreciably lower than the current level but larger than before the financial crisis.

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