The run off of its agency MBS make the Fed’s balance sheet reduction challenging given the tightening cycle
The Fed minutes for the March meeting indicate that the Fed balance sheet reduction is likely to progress sooner than expected. Whilst no concrete plan had been finalised, the minutes note that the process could begin "as early as after the conclusion of its upcoming meeting in May." The market consensus was that quantitative tightening would only start in July. The minutes also state that it "expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting" (https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20220316.pdf).
The Fed is acting to stem rampant inflation. To this end, Fed Governor Lael Brainard, traditionally a dove, said on Tuesday that "it is of paramount importance to get inflation down" and that the Fed will start "to reduce the balance sheet at a rapid pace as soon as our May meeting" (www.cnbc.com). According to the minutes, the tightening will be capped at $60bn/month for Treasuries and $35bn/month for agency MBS, phased in over three months (or longer if warranted by market conditions). Admittedly, this is considerably higher than the combined starting cap of $10bn/ month in 2017, but then again, the balance sheet size makes it a different beast altogether.
The Fed is currently holding approximately $3tn in MBS. Given rising rates, there is an inherent extension risk, impacting the Fed's reduction plans. Moreover, this exacerbates because prices of bonds typically come down as rates increase, meaning the Fed is likely to sell its longer-term holdings at a loss. Thus, there is pressure on the Fed as it attempts to run off its balance sheet. In addition to the stagflationary obstacle, this complication makes tighter monetary policy tricky to implement. However, given that the housing industry is almost 20% of the US economy, this process is another headwind that the Fed must manage as it looks to tighten aggressively.
Russell Shor
Senior Market Strategist
Russell Shor is a Senior Market Strategist at FXCM, having been promoted to the role in 2025 in recognition of his depth of insight and consistent delivery of high-impact market analysis. He originally joined FXCM in October 2017 as a Senior Market Specialist.
Russell holds an Honours Degree in Economics from the University of South Africa, is a certified FMVA®, and a full member of the Society of Technical Analysts (UK). With over 20 years of experience in financial markets, his work is renowned for its clarity, precision, and strategic value across asset classes.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites contained on this website are provided on an "as-is" basis, as general market commentary and do not constitute investment advice. The market commentary has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and it is therefore not subject to any prohibition on dealing ahead of dissemination. Although this commentary is not produced by an independent source, FXCM takes all sufficient steps to eliminate or prevent any conflicts of interests arising out of the production and dissemination of this communication. The employees of FXCM commit to acting in the clients' best interests and represent their views without misleading, deceiving, or otherwise impairing the clients' ability to make informed investment decisions. For more information about the FXCM's internal organizational and administrative arrangements for the prevention of conflicts, please refer to the Firms' Managing Conflicts Policy. Please ensure that you read and understand our Full Disclaimer and Liability provision concerning the foregoing Information, which can be accessed here.