What likely won’t change is the Fed favoring the policy rate as its primary tool to effect policy, with balance sheet reduction running in the proverbial background to maximize predictability and minimize market disruption. That, along with concerns that balance sheet reduction would lead to much higher interest rates at the long end of the yield curve, is why the Fed set monthly caps for letting bonds mature passively rather than planning to actively sell securities from its portfolio.
Another consideration relates to the eventual terminal size of the balance sheet in terms of ensuring adequate market liquidity and carrying out monetary policy, which would serve as a guide for when the Fed would end asset roll-off. At present, this terminal size is uncertain. However, as shown in the graphic using simplifying assumptions, Vanguard estimates that the balance sheet may settle around 18% of GDP, or just above $5 trillion, before the Fed begins winding down and eventually ending its roll-off, at which point it will allow its assets to grow in relation to the size of the economy. “That level could be reached around the end of 2025, barring any pauses or significant deviations from the currently communicated plan,” Hirt said.