The portfolio has swollen from about $900 billion in mid-2008 thanks to three rounds of bond-buying that left the U.S. central bank far and away the world's largest holder of government and mortgage debt. It is expected on Wednesday to announce a milestone in closing the book on the crisis era: that it will start the process of shedding bonds as soon as October.
The Fed's plan should slowly eat away at both its $2.5-trillion in Treasuries and $1.8-trillion in mortgage-backed securities (MBS) over the next few years, drawing the balance sheet down to somewhere in the range of $2.5-$3.5 trillion, according to Fed officials who say there is no need to decide the landing spot now.
The Fed wants to take advantage of low unemployment and sustained economic growth to clear room in its portfolio in case a future downturn forces it to ramp up purchases again.
The same reasoning informed its decision to raise interest rates four times since late 2015, which made the U.S. central bank something of a trail blazer for its international peers that are still struggling to boost inflation and growth.
The Fed is also responding to years of criticism from Republican members of Congress who say it has overstepped its remit by buying mortgage-backed securities, which stimulates the housing sector but not others. Letting bonds mature now, rather than selling later, could also avoid logging losses on the profit-making portfolio in years to come.
"There is no economic reason for shrinking the balance sheet. It's for political reasons," Willem Buiter, Citigroup's global chief economist, said at New York University's Stern School of Business this month. "The central banks hate visibility, and the size and composition of the balance sheet makes it very difficult."
The Fed aims to only gradually shed bonds and raise rates in part due to below-target inflation. Yet policymakers point to another reason to keep tightening U.S. monetary policy: the loosening of financial conditions this year, in which credit spreads have narrowed, stock prices have soared, and bond yields and the dollar have slipped.
Not all measures of corporate credit are robust, however. Bank loans to businesses, which grew by an average of about 10 percent year-over-year for the past five years, have levelled out this year.
(For a full interactive graphic of the effects of Fed bond-buying on the economy and markets, see: http://tmsnrt.rs/2jxgbbf)
(Reporting by Jonathan Spicer)
By Jonathan Spicer
