© Reuters. FILE PHOTO: Federal Reserve Bank of Dallas President Lorie Logan speaks at a conference of the National Association for Business Economics in Dallas, Texas, U.S., October 9, 2023. REUTERS/Ann Saphir/File Photo
By Howard Schneider
Federal Reserve Bank of Dallas President, Lorie Logan, stated on Friday that the Federal Reserve will need to gradually reduce its asset purchases and navigate its way towards a point where its asset holdings hit a low level. She emphasized the importance of monitoring a critical financial buffer to maintain bank reserves adequacy.
The usage of the Fed’s overnight reverse repurchase facility, known as ONRRP, has been on a steady decline, dropping from approximately $2.3 trillion last year to about $500 billion by the end of last month. This downward trend has prompted Fed officials to start deliberating on the timing and strategy to slow down the disposal of assets acquired to combat the economic repercussions of the pandemic. This is crucial to prevent reaching a stage where bank reserves become insufficient, which could trigger market instability.
Logan mentioned that once ONRRP balances reach a minimal level, it will be necessary to decelerate the asset runoff process. The presence of significant balances in the ONRRP facility indicates ample liquidity within the financial system. However, uncertainties arise when the repo facility’s balances deplete to zero, leading to ambiguity regarding the surplus liquidity.
In anticipation of the appropriate excess liquidity threshold, Logan highlighted the importance of observing money market spreads and volatility to make informed decisions gradually. She acknowledged the challenges in pre-determining the optimal liquidity level and suggested a cautious approach through careful observation and adjustment based on market indicators.
Echoing sentiments from a recent research paper, Logan discussed how central banks’ efforts to shrink their asset holdings have had a lesser impact on markets compared to expanding balance sheets during periods of economic downturns. She attributed this “asymmetry” to the rapid deployment of quantitative easing measures during crises, contrasting with the more gradual and predictable nature of tightening programs.
While Logan refrained from specifying a definitive endpoint for the balance sheet reduction, she supported the notion of a slower runoff, as mentioned in the Fed’s January meeting minutes. This approach could facilitate a smoother adjustment process for banks and potentially lead to a reduced overall balance sheet size.
Logan’s remarks align with the discussions among policymakers at the January meeting, where initiating a gradual taper of Quantitative Tightening (QT) was proposed to prolong the balance sheet reduction timeline and achieve a smaller balance sheet size in the long run.