Fed to reduce Treasury maturity cap to $5 billion

The Federal Reserve announced it will slow down its balance sheet drawdown starting next month. This decision comes due to issues with the government's borrowing limit. The cap for Treasury maturities will be reduced from $25 billion to $5 billion per month, starting on April 1. The announcement was made during a Federal Open Market Committee (FOMC) meeting. The Fed kept interest rates unchanged as officials face uncertainties about the economy. Fed Governor Christopher Waller disagreed with the decision to slow the drawdown. The Fed's change is part of a process known as quantitative tightening (QT), which aims to reduce the central bank’s bond holdings. The monthly limit for mortgage-backed securities will remain at $35 billion. Some banks expected this change, but many thought it would be temporary. Fed Chair Jerome Powell emphasized that this slower pace would help with a smoother end to QT. Market participants interpreted this slowdown as a soft stop to the drawdown of Treasury holdings. Analysts noted this is the second reduction in QT since it started. The QT process has been active since 2022, aiming to remove liquidity added during the COVID-19 pandemic. To provide support earlier, the Fed previously bought a large amount of bonds, increasing its holdings to $9 trillion. So far, the Fed has reduced its balance sheet by over $2 trillion. The ongoing debt ceiling issue complicates the situation for the Fed. The Treasury is currently using its funds at the Fed to meet expenses, which adds liquidity to the system. If the debt ceiling is raised, the Treasury will likely try to rebuild its account, taking liquidity back out. This makes it hard for the Fed to assess the market’s liquidity accurately. Overall, by slowing QT, the Fed aims to manage the process more carefully, reducing risks to financial markets as it approaches its end goals.