Powell Haunted by Repo Crisis as Fed Aims to Cut Balance Sheet

Tucked away in hours of congressional testimony by Federal Reserve Chair Jerome Powell last month was an admission that the central bank was blindsided by the impact of shrinking its balance sheet four years ago.

While Powell assured lawmakers the Fed is committed to avoiding a repeat of 2019 — when the repo market, a key part of US financial plumbing, seized up — Wall Street economists and strategists caution that quantitative tightening remains complex and hard to predict. Known as QT, it involves letting Fed bond holdings mature without replacement, draining cash from the financial system.

In the coming months, the full brunt of the Fed’s current QT program is set to be felt. How it proceeds, and how the Fed handles the process, could shape its political latitude to keep using its balance sheet as a key tool in the future, amid Republican angst that was on display in Powell’s June 21-22 hearings.

“We didn’t see it coming,” Powell acknowledged at the House Financial Services Committee on June 21 when referencing the sudden problems that emerged in 2019 and forced the central bank into steps it didn’t want. The advantage now is “we have experience,” he said.

Fed's Two Key Liquid Liabilities | Powell prefers RRP to drop versus bank reserves

The Fed is currently shedding its bond holdings at an annual pace of roughly $1 trillion, much faster than in 2019 but from a much bigger base. Powell told lawmakers he’s “very conscious” of the importance of not just inflating the balance sheet during each easing cycle and leaving it enlarged.