Federal Reserve is quickly filing the details of how it is going to reduce the securities portfolio by 4.5$ billion in the years ahead, this process could start this year and can become the challenge for investors which are grown habitual to easy money from world’s most important central bank.
Federal Reserve wants to decrease its portfolio for several reasons. U.S economy is getting stronger and now requires less support from large bond purchasing portfolio. According to Federal Reserve, large holding have become political liability which is unpopular in congress as well. Moreover, the reduction in Federal Reserve bond purchasing portfolio could relieve pressure on new Federal Reserve leadership in 2018, after the end of present chairwoman Jannet Yellen’s term.
In their March meeting Fed moved closer to an agreement on the plan according to interviews with Federal Reserve officials.
If the economy perform as predicted by the Fed, the bank could begin allowing its holdings of Treasury securities and mortgage bonds to mature without reinvesting all of the proceeds into new securities later this year.
The Fed's portfolio is providing less support to the economy than before because it is holding fewer bonds with long maturities. Holding long-maturity bonds is stimulative because these are especially risky assets. Constraining the supply of these risky assets sends investors in search of other risky assets, pushing up the values of stocks, corporate bonds and others private holdings.
At the end of 2013, the Fed owned nearly $750 billion in U.S. Treasuries with maturities between seven and 10 years. That total had fallen to $200 billion at the end of last year and is on track to reach $100 billion at the end of this year, according to FTN Financial.
Even though the Fed will shrink its holdings from current levels, it will end up with more assets than it did before the crisis because its liabilities have grown -- there's more currency in circulation and the U.S. Treasury has increased its cash balance.
The Fed needs to manage the composition of its holdings.
Officials have said once they get the balance sheet to its steady state, they want almost all central bank holdings in Treasurys, not mortgages. But because their mortgage bonds have longer durations than Treasuries, the Fed could hold a much larger share of mortgage bonds once their balance sheet stabilizes. This could prompt the Fed to remix its portfolio down the road, perhaps by reinvesting principal from maturing mortgages into Treasuries.
To avoid roiling markets, officials aren't inclined to engage in large-scale sales of their mortgage holdings.