Fed to Slow Balance-Sheet Runoff at Jan. 28 Meeting, Cutting Treasury Cap to $15 Billion, Officials Say

Fed Prepares to Ease Runoff Pace

The Federal Reserve plans to announce next week that it will slow the pace at which it shrinks its $6.8 trillion balance sheet, lowering the monthly cap on Treasury securities redemptions from $25 billion to $15 billion, according to two Fed officials familiar with the discussions. The decision, reached during a series of calls among Board of Governors members and reserve bank presidents this week, is expected to be disclosed in the policy statement following the Federal Open Market Committee meeting scheduled for Jan. 27 and Jan. 28 in Washington, the officials said.

The move would mark the first adjustment to the Fed's balance-sheet normalization program since the central bank began reducing its securities holdings in June 2022. Under the current plan, the Fed allows up to $25 billion in Treasury securities and up to $35 billion in mortgage-backed securities to mature each month without reinvesting the proceeds. The new framework would keep the mortgage cap unchanged while reducing the Treasury runoff ceiling, one official said. The Fed would also update its guidance to indicate that it intends to maintain a significant Treasury securities portfolio for the foreseeable future, according to the second official.

The Fed's balance sheet stood at roughly $6.83 trillion as of Jan. 22, down from a peak of $8.96 trillion in April 2022. Reserve balances held by depository institutions at the central bank have fallen to approximately $3.1 trillion, a level that some officials worry is approaching the lower bound of what banks need to manage payments and satisfy regulatory liquidity requirements. In 2019, a similar drawdown in reserves contributed to a spike in overnight repurchase agreement rates, forcing the Fed to intervene in funding markets.

Staff at the Board of Governors presented updated estimates to governors during a briefing on Jan. 20 showing that the "ample reserves" threshold may be closer than previously assumed, one official said. The presentation included projections that reserve demand could exceed available supply by the second quarter of 2026 if runoff continued at the current pace, the official added. That analysis helped build consensus for a technical adjustment rather than waiting for market stress to emerge.

A trader at a primary dealer firm that transacts directly with the New York Fed said senior staff at the Markets Desk briefed counterparties on Thursday that reserve-management conditions had shifted enough to warrant a technical adjustment. The trader, who spoke on condition of anonymity because the discussions were confidential, said the desk had noted signs that overnight funding markets were becoming less elastic, including a widening in the spread between the effective federal funds rate and the interest paid on reserve balances.

Market Reaction and Treasury Impact

News of the impending adjustment moved Treasury markets Friday afternoon. The yield on the 10-year Treasury note fell 8 basis points to 4.42 percent by 3:30 p.m. Eastern Time, while the 2-year yield dropped 6 basis points to 4.18 percent, according to Bloomberg data. The MOVE Index, which measures bond-market volatility, declined 4 percent. An economist at a Wall Street firm said the announcement would relieve pressure on longer-dated securities by reducing the supply of Treasuries that the private market must absorb each month.

Banks and money-market funds have been among the most active buyers of Treasury bills and notes as the Fed stepped back from reinvestment. A slower runoff would mean the Fed retains more securities on its balance sheet, leaving less supply for private investors to purchase each month. The change could also affect the level of reserves in the banking system, potentially easing upward pressure on short-term funding costs and reducing the likelihood that the effective federal funds rate drifts toward the upper end of the central bank's target range.

The quarterly refunding announcement from the Treasury Department, expected on Jan. 29, had already led dealers to brace for elevated issuance of 10-year and 30-year notes. By slowing runoff, the Fed would indirectly reduce the net amount of duration the market must digest, the economist said. The Treasury is expected to announce $125 billion in refunding auctions for the week of Feb. 9, including $42 billion in 3-year notes, $43 billion in 10-year notes, and $22 billion in 30-year bonds, according to a survey of primary dealers.

The decision does not imply a change in the federal funds rate, the Fed officials emphasized. Futures markets currently price in roughly a 62 percent probability that the FOMC will hold the benchmark rate at 4.25 to 4.50 percent at the Jan. 28 meeting, according to CME Group data. Instead, the balance-sheet adjustment reflects growing concern among policymakers that continued rapid runoff could strain bank reserves and disrupt short-term funding markets, particularly as the Treasury General Account rebuilds following the most recent debt-ceiling episode.

What Comes Next

The Fed's post-meeting statement on Wednesday afternoon is expected to include new language stating that the committee will slow the pace of decline in its securities holdings "to ensure a smooth transition to an ample-reserves regime," one official said. Chair Jerome Powell is likely to address the change during his press conference at 2:30 p.m. Eastern on Jan. 28, according to the official. The central bank also plans to release an updated set of principles for balance-sheet normalization alongside the statement.

Primary dealers said they expect the New York Fed to publish technical FAQs explaining how the new $15 billion Treasury cap will apply to securities maturing above the limit. The change would take effect with the March 1 monthly redemption cycle, the trader said. If the Fed continues at the reduced pace, its Treasury holdings would fall by roughly $180 billion over the next 12 months, compared with approximately $300 billion under the current schedule.

Investors and bank treasurers will watch the Fed's language on reserve scarcity for clues about when the central bank may halt runoff entirely. Two Fed officials said a complete stop is not expected at the January meeting but could be discussed as soon as the session scheduled for March 17 and March 18 if funding-market pressures persist. The officials cautioned that the plan could still change over the weekend as staff finalize the statement language.

Major news organizations are expected to match elements of the story by Monday or Tuesday as officials continue briefing primary dealers and foreign central bank counterparts. The Fed's Board of Governors declined to comment.