Just in time for Halloween, but ideally without the fright factor.
The Federal Reserve will probably begin in October to shrink a balance sheet that swelled to $4.5 trillion after the financial crisis, investment bank Morgan Stanley (MS) predicts, trimming as much as $30 billion by the end of this year and no more than $300 billion in the first 12 months.
Fed officials said in minutes of the monetary policy committee's May meeting that they expect to use a system of gradually escalating caps on the amount pared from the central bank's holdings in order to avoid upheaval in financial markets due to concerns about how much liquidity would evaporate.
"The caps would initially be set at low levels and then be raised every month, over a set period of time," according to the minutes. The Fed began buying Treasury bonds and mortgage-backed securities by the billions per month to stimulate economic growth after the 2008 crisis froze credit and sent unemployment soaring.
Even after the central bank stopped new purchases, it reinvested proceeds from maturing securities to maintain the portfolio's size. The goal of shrinking it now is to reduce the Fed's deep involvement in global financial markets while curbing incentives for companies to load up on cheap debt.
Reversing so-called quantitative easing would also help the central bank to skirt criticism over its payment of above-market interest rates on foreign lenders' deposits.
During the first year of what might be termed quantitative tightening, the Fed will probably increase its caps from $10 billion a month to $40 billion a month, or as much as $480 billion a year, until its balance sheet reaches pre-crisis levels, Morgan Stanley economist Ellen Zentner said in a note to clients.
