NY Fed sees balance sheet falling $2.5 trln by mid-2025, when run-off stops By Reuters

WASHINGTON (Reuters) -The Fed’s holdings of Treasury bonds and mortgage backed securities is projected to decline by roughly $2.5 trillion by mid-2025 to roughly $5.9 trillion, when the central bank’s run-off of assets is likely to be halted to maintain an adequate level of bank reserves, the New York Fed said on Tuesday.

But that run-off will do little to trim what is the most controversial portion of the Fed’s portfolio, the $2.7 trillion in mortgage-backed securities held by the Fed. Under the New York Fed’s projections the portion of assets held in MBS would remain roughly constant through 2025, with the central bank still holding roughly $1 trillion of those securities by 2030.

The expected slow run-off of MBS has prompted some policymakers to call for sales of those securities, particularly given the strength of the U.S. housing market.

The New York Fed’s annual report on its open market operations provides a key glimpse of how the Fed’s asset holdings, which ballooned to $9 trillion during the pandemic as it bought assets to stabilize core financial markets, will evolve now that the Fed is letting its balance sheet shrink.

Monthly declines will be about $80 billion monthly through 2024, the New York Fed estimated.

The decline will continue for about three years, the New York Fed said, at which point the Fed’s holdings could be held constant, at an estimated 22% of gross domestic product, then grow again in proportion to the economy.

Reserves required by the banking system are included in that amount, which the New York Fed estimated at around 8% of gross domestic product.

The report also highlighted risks around the Fed’s transition to a smaller balance sheet at a time when interest rates are rising. One of the Fed’s tool for raising short term market interest rates is to pay more for reserve deposits held by banks at the Fed. Just as those expenses rise, the Fed’s roll-off of its own holdings mean it will be earning less in interest payments from its Treasury bonds and mortgage securities.

Under current projections Fed “net income is projected to decline notably,” the New York Fed said, meaning smaller profits to be turned back to the U.S. Treasury.