The FOMC looks at normalizing the size of its balance sheet

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The September FOMC meeting

The Federal Open Market Committee (or FOMC) members had last met on September 16–17, in their sixth meeting of 2014. As part of their agenda, members discussed the state of the U.S. economy and ways to direct its future course. The September meeting was important also because it was followed by the Fed releasing its third quarter Statement of Projections (or SEP). The SEP includes the FOMC’s updated projections for economic growth, inflation, and unemployment.

Fed's Balance sheet

The September taper

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Satisfied by the overall pace of economic recovery, the committee decided to taper its asset purchase program by another $10 billion. The Fed’s monthly asset purchases came down to $15 billion starting in October, including $10 billion in longer-term Treasuries (BND) and $5 billion in agency mortgage-backed securities.

The committee had also made another important announcement. If labor market conditions continued to improve and inflation was in line with its long-run targets, the FOMC would “end its current program of asset purchases at its next meeting.”

The Fed’s balance sheet

Three rounds of quantitative easing (or QE) have increased the Fed’s balance sheet to an unprecedented $4.5 trillion on October 22, 2014—from ~$0.9 billion at the start of 2008. Now, the Fed is looking at normalize its balance sheet size. Reducing the size of the Fed’s Treasury (BND) and agency-backed debt holdings will have a massive impact on Treasuries (TLT)(IEF) and mortgage rates (VNQ)(IYR).

The October FOMC meeting helps take another step towards the Fed’s current aim of normalizing its balance sheet, given that macroeconomic conditions remain favorable. The next part of this series talks about key observations and decisions from the FOMC meeting held over October 28–29.

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