Sunday, June 12, 2011

Fed balance sheet after QE2

With weaker economic data, the Fed is placed in a difficult situation. QE2 ends this month but it is unclear what the Fed should do with the roll-off of maturing bonds and principal payments from mortgages. The Fed balance sheet is now at 2.82 billion up from &870 million in December 2007. The bulk is in Treasuries at $1.6 trillion and $920 billion in mortgages.

The passive strategy of letting principal and interest roll-off would seem to be the easiest means of reducing the balance sheet. The mortgage portfolio actually is over $100 billion smaller than a year ago just because of principal and interest declines. Still, the problem will be the speed at which the portfolio will decline. If growth will be slow, there is less desire to have the portfolio decline. On the other hand, cash flow could be used to buy more securities and hold the balance sheet stable. At this time, it s not clear hat is the specific Fed plan.

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