The Federal Reserve is ending the drawdown of its balance sheet due to tightening money market liquidity and dropping bank reserve levels. The Fed will hold steady its stock of government bonds and reinvest proceeds from maturing mortgage-backed securities into Treasury bills starting December 1. The Fed also trimmed the fed funds rate by a quarter percentage point.

Federal Reserve Chair Jerome Powell stated that the balance sheet runoff would stop when reserves were above ample reserve conditions. Rising borrowing costs in short-term lending markets led to the expected shift in the Fed’s balance sheet plans. Recent days have seen higher federal funds rates and increased activity in the Fed’s Standing Repo Facility.

The Fed’s decision to end quantitative tightening (QT) sooner than expected indicates there is enough liquidity in the financial system to maintain control over interest rate targets. QT aimed to reduce excess liquidity added during the pandemic, with most QT efforts targeting cash parked in the reverse repo facility. The Fed’s balance sheet will be larger than pre-pandemic levels.

Analysts predict the Fed will need to start expanding its holdings to keep financial system liquidity appropriate for an expanding economy. The next step may involve expanding the balance sheet by $20 billion per month to match the expansion of GDP. The Fed will also need to consider the composition of its holdings and addressing the slow reduction of mortgage bonds.

Read more at Yahoo Finance: Fed winding down balance sheet contraction amid tightening money markets