US Fed to reduce monthly redemption cap on Treasury securities to $5 billion: How will this impact investors?

The US Federal Reserve announced that starting next month, it will slow the pace of its balance sheet drawdown amid an ongoing standoff over lifting the government’s borrowing limit. This will likely hold for the remainder of the process.

The announcement came as part of the US Federal Open Market Committee (FOMC) meeting, which left the US central bank’s interest rate unchanged. US policymakers deal with considerable uncertainty about the economic outlook tied to the Trump administration's aggressive and chaotic policy changes.

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US Fed's balance sheet move

On Wednesday, US Fed Governor Christopher Waller dissented against the balance sheet drawdown shift. The US Fed said that as part of the reduction in the pace of quantitative tightening (QT), the monthly cap of Treasuries will be allowed to mature but drawn down to $5 billion per month from the prior $25 billion monthly cap, effective on April 1. The mortgage-backed securities cap will hold steady at the current $35 billion limit.

US Fed Chair Jerome Powell, speaking in a press conference after the FOMC meeting, strongly indicated that the slower pace of the drawdown would not change and would also help lead to a smoother end for QT. Powell said Fed officials "came to be pretty strongly in favour of this move," which may also extend the central bank's ability to run QT before needing to stop.

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This is the second downshift in QT, and the monthly drawdown for treasuries was at $60 billion until last May. At the post-policy press conference, Fed chair Powell asked why the Fed had not also slowed the drawdown pace for mortgage-backed securities and noted that it may happen one day.

Throughout the QT effort, the US Fed has struggled to reach the cap for that type of security due to conditions in the housing market where mortgage creation has been very slow and refinancing activity light amid a shift higher in rates.

Understanding the US Fed's quantitative tightening

The US Fed’s QT process has been running since 2022 and is designed to strip liquidity added during the COVID-19 pandemic and its immediate aftermath from the financial system. To stabilize the financial system and provide stimulus, the US Fed bought Treasury and mortgage bonds aggressively, more than doubling the size of its holdings to a peak of $9 trillion.

QT has helped the US Fed shed over $2 trillion from its balance sheet. Comments from Fed officials have suggested that all else being equal, the financial system still has enough excess liquidity around that QT has some distance left to go.

The latest worry in the QT effort is the debt ceiling, which limits how much the government can borrow. Faced with this roadblock, the Treasury is using cash from its Fed account to pay bills, which is adding liquidity to the system. When the debt ceiling is raised, assuming that happens, the Treasury will likely seek to rebuild its account, taking liquidity back out of the system.

Also Read: ‘US Fed ‘well positioned’ for risks amid Trump tariffs’: Jerome Powell reiterates ‘go-slow’ approach on rate cuts

How will US Fed's balance sheet pace impact investors?

According to analysts, the shrinking of the Fed's balance sheet should be viewed as a victory since only improvement in the economy's prospects is likely to bring it about. The balance sheet move signalled the US central bank's determination to keep interest rates low, encouraging investment by increasing risk appetite in financial markets on greater liquidity.

“The US Fed plans to slow the pace of balance sheet reduction by adjusting the monthly redemption cap on Treasury securities by April. The FOMC decisions have mixed implications for currency movements, capital flows and market sentiment in India,” said Dr Ravi Singh, SVP – Retail Research at Religare Broking Ltd.

"Higher US interest rates could lead to foreign capital outflows from Indian markets, whereas lower rates may attract investment. Economic uncertainty in the US could contribute to market volatility. However, a stronger dollar may impact global commodity prices. As India is a major oil importer, lower oil prices could benefit the Indian stock markets," added Dr Singh.

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts, consider individual risk tolerance, and conduct thorough research before making investment decisions, as market conditions can change rapidly, and individual circumstances may vary.