Fed's reverse repo facility drawdown looms large in balance sheet debate

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Watch onNEW YORK - The eventual end of the Federal Reserve’s efforts to reduce its vast bond holdings increasingly appears tied to what happens with the central bank's"reverse repo" operations.

Some central bankers and market participants are gravitating to the view that when the reverse repo facility is largely drained, or is at least much lower than it is now, overall financial sector liquidity will be tight enough for the Fed to at a minimum start considering ending the ongoing drawdown of bonds it holds on its balance sheet, if not halt the process completely.

So far, reverse repos have “come down very smoothly,” Lorie Logan, president of the Dallas Fed said earlier this month. Assuming a recession isn’t the driver of the stop, Wells Fargo sees a number of different scenarios confronting the Fed. In 2019, during its first QT effort, officials allowed reserves to shrink too much, causing the federal funds rate to spike and forcing the Fed to intervene to return it to its targeted range. New tools like the Standing Repo Facility, which can add low-cost liquidity to the system, and lessons learned from the last episode have given central bankers confidence they won’t have a replay of that episode.

Lou Crandall, chief economist with Wrightson ICAP, a research firm, said Fed policymakers are"highly mindful of the fact that the trigger signs this time might be different from the last time."

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