Fed Watchers Rein In Estimates of How Big Balance Sheet Will Get

The Federal Reserve’s balance sheet will probably peak at a smaller size than previously expected due to improved trading conditions in financial markets and low demand for the U.S. central bank’s Covid-19 emergency lending programs.

Weekly figures published Thursday showed the size of the Fed’s balance sheet fell for a fourth straight week, bringing it back below $7 trillion. From early March to mid-June, it expanded by $3 trillion as central bankers pumped cash into the financial system via short-term loans and purchases of debt securities to alleviate investor panic as the virus spread.

“Balance-sheet estimates are largely coming down because backstop programs aren’t being utilized to as much of an extent as people may have expected,” said Blake Gwinn, a rates strategist at NatWest Markets.

Fed Watchers Rein In Estimates of How Big Balance Sheet Will Get

The short-term loans are now coming due and borrowers -- mainly dealer banks and foreign central banks -- aren’t rolling them over as market conditions return to a more-normal state. At the same time, the spate of unprecedented emergency lending programs the Fed launched to backstop corporate and municipal borrowers over a longer period in response to the pandemic aren’t seeing much take-up so far.

Andrew Hollenhorst, chief U.S. economist at Citigroup Inc., now sees the Fed’s balance sheet peaking around $8 trillion in the coming months instead of $9 trillion. Mark Cabana, a rates strategist at Bank of America Corp., said he expects the balance sheet to rise to $7.6 trillion by the end of the year instead of $10 trillion.

Dollar Swaps

Hollenhorst and Cabana cited a decline in the amount of foreign-exchange swaps outstanding with the U.S. central bank’s counterparts abroad, which by the end of May had risen to $449 billion but have since fallen to $179 billion.

Both also pointed to the lack of take-up in the Fed’s so-called Main Street Lending Program for mid-size U.S. companies, which was announced in March but didn’t launch until Monday. The weekly balance-sheet data showed that as of Wednesday, the Fed hadn’t purchased any loans made by banks under the program, which has $600 billion in lending capacity.

Another emergency program for state and local governments known as the Municipal Liquidity Facility, which has $500 billion in lending capacity, has so far only disbursed a single loan -- for $1.2 billion, to the state of Illinois.

Corporate Bonds

The Fed has to date accumulated $10.7 billion of corporate debt through its emergency program to backstop the market where larger companies borrow. But the $710 million increase over the past week marked the smallest rise since the Fed began making purchases in that market in mid-May.

“As market functioning has improved, we have slowed the pace of purchases, from about $300 million per day to a bit under $200 million a day,” Daleep Singh, head of the markets group at the New York Fed, said Wednesday.

“If market conditions continue to improve, Fed purchases could slow further, potentially reaching very low levels or stopping entirely,” Singh said, while adding that “should conditions deteriorate, purchases would increase.”

©2020 Bloomberg L.P.

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