The normalization of U.S. Federal Reserve policy should really go like this: First, the central bank starts to hike rates, it allows maturing securities to run off, which results in its balance sheet shrinking.
But because the Fed has expanded its balance sheet to US$5.4-trillion from US$900-billion in August 2008, things might go a little different this time around. That’s in large part because the US$210-billion of Treasury securities held in the Fed’s System Open Market Account (SOMA) mature in 2016, with roughly two-thirds of that maturing within the first part of the year.
“What this means is that the Federal Reserve will have to make decisions about the trajectory of economic policy between now and also the start of 2016,” said Scotiabank economist Dov Zigler.
He thinks indecision would be a difficult and increasingly unpalatable option, equivalent to tightening monetary policy as the Fed’s balance sheet would shrink.
Doing nothing, Mr. Zigler pointed, implies that the Fed’s balance sheet would contract up to US$1.1-trillion through 2019 just from maturing Treasury securities.