Here’s how to read the Fed’s latest balance-sheet move

The Federal Reserve opted to slow its balance-sheet runoff further at its March policy meeting, but investors shouldn’t assume this move could notably ease upward pressure in Treasury yields.

At the conclusion of the March 18-19 meeting, policymakers announced that beginning in April, the Fed will reduce the monthly redemption limit on Treasury securities to $5 billion from $25 billion. The Fed will keep its cap on agency debt and mortgage-backed securities at $35 billion.

What this means, in practice, is that when $25 billion of the central bank’s Treasury holdings mature, it will replace them with another $20 billion starting in April, thus adding $20 billion of monthly demand to the Treasury market. That could push Treasury yields lower, and prices higher. [Bond prices move inversely to yields.]

Some analysts interpreted the move as a purposeful attempt to lower long-term bond yields, in line with what Treasury Secretary Scott Bessent and other Trump administration officials have desired. The question following the Fed’s latest balance-sheet decision is whether a lessening of the headwinds to the Treasury market inevitably means more of a tailwind. The answer, for now, is not quite.

Fed Chair Jerome Powell characterized the move on Wednesday as a “common sense adjustment" that the Fed was undertaking as its balance sheet gets closer to an ample level. Slowing the pace of the balance-sheet runoff reduces the risk that the Fed inadvertently restricts liquidity. While the flows in and out of the Treasury General Account got Fed officials thinking about slowing or pausing the runoff, Powell noted that the decision to slow had no implication for monetary policy, nor for the ultimate size of the balance sheet.

“It isn’t sending a signal in any hidden way," Powell said.

New York Federal Reserve President John Williams said on Friday that he saw the decision to slow what’s known as quantitative tightening as a “natural next step to smooth the transition from abundant reserves to a level that is somewhat above ample."

Fed governor Christopher Waller pushed back on the decision to slow, however, and formally dissented at the meeting. Noting that the current level of reserve balances stands at more than $3 trillion, he said in a statement on Friday that this level is “abundant," making a slowdown unnecessary at this stage.

“The committee slowed the pace of redemptions in June 2024 to help ensure a smooth transition to the appropriate level of securities holdings needed to implement monetary policy efficiently and effectively. I believe that pace continues to be the right one," Waller said.

Waller noted the Fed has a variety of tools to address any shocks that could emerge. “Rather than changing our current pace of balance-sheet reduction, the Federal Reserve should rely on those tools and develop a plan for how to respond to short-run strains if they emerge," Waller said.

The Fed lowered the redemption cap on Treasuries last June from $60 billion to the current $25 billion level.

While the Fed potentially will become a bigger buyer of Treasuries, there are other, more significant issues that can push yields around, Tom Essaye wrote on Friday in the Sevens Report. Federal policy changes and economic conditions will probably have a greater impact on yields in the coming weeks and months.

Essaye wrote that slowing the balance-sheet runoff isn’t aimed at stimulating the economy. “This does not add a tailwind to stocks or bonds; it just reduces the strength of the headwind because the Fed is still reducing its balance sheet," he said.

Write to Megan Leonhardt at megan.leonhardt@barrons.com