US Fed Policy: Wall Street Awaits End Of Balance Sheet Runoff-What Does This Mean For Investors?

The US Federal Reserve is all set to announce its monetary policy decision on Oct. 29, after a two-day review meeting to deliberate on the central bank's benchmark interest rate verdict and the state of the US economy. The market has baked in a quarter point cut this week, bringing the federal fund rate to a range of 3.75%-4.00%. With the rate cut expected, Wall Street has turned its attention to the Fed's balance sheet management.

According to experts, a possible end this week to the US Fed's "quantitative tightening" policy may offer a boon to the US government. Most market watchers assumed quantitative tightening - letting bonds roll off the Fed's balance sheet - would continue through early 2026. However, Fed Chair Jerome Powell flagged a likely end to the whole QT process in the "coming months".

An unexpected and volatile rise in the money market rates, including an upward drift in the federal funds rate, has motivated analysts to call for the US Fed to end the shrinkage of its bond holdings. Powell's indication came after heavy government bill sales triggered a change in the money market system.

The end of QT may help facilitate the government's current funding strategy that has been in place since mid-year and has seen Treasury rely more heavily on short-maturity bills of 12 months or less. According to news agency Reuters, the share of Treasury bills in the ever-expanding US debt stack is set to jump above historical averages and hit 25% by year-end.

An imminent end to QT may smooth this process by allowing the "steady state" of the Fed's balance sheet to tilt more toward bills over time, leaving the US Fed and Treasury well-aligned. As it stands, bills are only just over 16% of the Fed's balance sheet, whereas Treasuries of 10-year maturities or more make up 38% and one-to-five-year tenors account for 34%.

After more than doubling the size of its balance sheet with aggressive purchases of Treasury bonds and mortgage-backed securities as a stimulus tool during the COVID-19 pandemic, the Fed has reduced the size of its holdings from a peak of about $9 trillion in 2022 to the current level of $6.6 trillion.

Brad Bernstein, managing director at UBS Private Wealth Management, told Reuters that while investors are expecting a quarter percentage point rate cut from the Federal Reserve on Wednesday, "the most important thing the market is watching for" is what the central bank "will do with its balance sheet."

According to Bernstein, the US Fed may announce an end to runoff of securities on their balance sheets. To be clear, every month, billions of dollars mature in Treasuries and mortgage-backed securities. ''They've been allowing a lot of that to runoff, reducing their balance sheet. They may announce that's going to end before the end of the year.''

The Wall Street expert believes that will be a positive catalyst for markets going forward and in the next year. The balance sheet is a major way that the Fed impacts interest rates in the economy. ''They control the discount rate and they control their balance sheet. It has been in a tightening bias up until now," said Bernstein.

"If the Fed stops the balance sheet runoff, they're going to be another buyer of tens of billions of Treasuries every month, effective immediately, which will support the market. It also directly impacts the way banks have a direct access to liquidity and capital. So, its very important for markets and the economy that the Fed, in the near future, stops the tightening of its balance sheet," he concluded .