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Easing rates, as the Fed says, will slow the pace of balance sheet tightening.

Federal Reserve policymakers say they will reduce the pace of “quantitative tightening” by $40 billion a month, less than half the pace envisioned 2 years ago.

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Mortgage rates appeared poised to fall on Wednesday after Federal Reserve policymakers said they would slow the pace of “quantitative tightening” — the central bank’s $7 trillion balance sheet drain. Doing so has helped keep rates high — less than half the pace envisioned two years ago.

At its latest meeting, the Fed left short-term federal funds rates unchanged at 5.5 percent from its current target of 5.25 percent, as expected.

But following guidance Fed Chair Jerome Powell provided in March, on June 1 the Fed will reduce the pace at which it will reduce its long-term Treasury holdings by $35 billion per month.

Because the Fed hasn’t met its goals for reducing its holdings of mortgage-backed securities (MBS), the easing of the Fed’s balance sheet will soon total just $40 billion a month — the $95 billion set by policymakers. Less than half of the target. In 2022

“The decision to slow the pace of runoff doesn’t mean our balance sheet will ultimately shrink less than it would otherwise, but we have to do that,” Powell said at a press conference after the Fed’s latest meeting. allows the final level to be reached more slowly,” Powell said at a press conference after the Fed’s latest meeting. .

“In particular, reducing the speed of run-off will help ensure a smooth transition, reducing the likelihood that currency markets will experience stress, and thus our securities holdings.” will help facilitate ongoing drawdowns consistent with reaching adequate levels of sufficient reserves.”

10-year Treasury yields retreat from 2024 highs.

Source: Yahoo Finance.

Production on 10-year Treasury notewhich are one A useful barometer While mortgage rates are on the rise next, Wednesday fell nine basis points to 4.59 percent, down 15 basis points from the 2024 high of 4.74 registered on April 25.

But Marty Green, principal at the mortgage law firm Polinsky Battle Green, noted that the chances of a Fed rate cut this year appear to be receding.

Marty Green

“With inflation data continuing to show a bumpy road to the Fed’s 2 percent inflation target, it’s not surprising that the Fed left interest rates unchanged and that interest rates will remain unchanged until the end of this year. is delaying the possibility of a reduction,” Green said. a statement.

“The question now is whether inflation proves so sticky that the Fed decides that a rate cut in 2024 is no longer in the cards and will instead be delayed until 2025.”

gave CME FedWatch Toolwhich tracks futures markets to gauge the odds of future Fed moves, on Wednesday put the odds of the Fed cutting more than one rate this year at just 42 percent, which is is less than 85 percent on April 1.

Green described the Fed’s decision to slow the pace of balance sheet tightening as “good news.”

“Over time, this adjustment will have some positive effect on interest rates without the Fed needing to adjust the fed funds rate,” Green said.

Fed to slow ‘quantity tightening’ pace

Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis.

While the Fed has tight control over short-term interest rates, long-term interest rates on government debt and MBS are driven by supply and investor demand.

To keep the economy from sinking during the pandemic, the Fed not only brought short-term interest rates down to 0 percent, but is buying $120 billion of debt every month — $80 billion in long-term Treasury notes and $40 billion in MBS.

As its balance sheet approached $9 trillion, the Fed reversed course from “quantitative easing” and began “quantitative tightening” as part of its efforts to fight inflation.

In 2022, the Fed ramped up “quantitative tightening” with a goal of trimming $60 million from its balance sheet and $35 billion in MBS each month. Instead of replacing $95 billion in maturing assets to maintain the status quo, the Fed will let those assets roll off its books.

Now, instead of paying $60 billion in government debt off the books each month, the Fed has set a new cap on Treasury redemptions at $25 billion per month.

Although the Fed is leaving the $35 billion runoff cap on MBS in place, it has fallen short of that target. As high mortgage rates have slowed the pace at which borrowers refinance their mortgages, the Fed has been able to reduce its mortgage holdings by as much as $15 billion a month for some time.

Asked if there was a contradiction in the Fed holding short-term rates steady to try to cool the economy while slowing the pace of quantitative tightening, Powell said rates are an “active tool of monetary policy.”

Fed policymakers are slowing the pace of quantitative tightening to avoid this kind of thing. The disruption experienced by currency markets. The last time it tried to trim its balance sheet was in 2019, he said.

“This is a plan that we’ve implemented for a long time … not to accommodate the economy or make the economy less restrictive,” Powell said. “It’s really about making sure that shrinking the balance sheet to where we want to get it is a smooth process, and doesn’t end up with financial market turmoil like it did last time we did it. What was and only the second time we’ve done that.”

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