By Michael S. Derby

NEW YORK (Reuters) – Wall Street’s biggest banks have pushed back the expected endgame for the Federal Reserve’s ongoing efforts to shrink the size of its balance sheet, according to meeting minutes from the Federal Reserve’s most recent policy gathering.

Banks informed the Fed before the December policy meeting that they projected this process would conclude in June of this year, slightly later than their previous estimation of November. This detail emerged from the minutes of the December Federal Open Market Committee meeting, which recounted a briefing by a New York Fed official responsible for monetary policy implementation.

During the Fed’s latest meeting on December 17-18, officials adjusted their interest rate target range downwards by a quarter percentage point to between 4.25% and 4.5%. They also reduced expectations for future rate cuts and revised upwards their inflation trajectory estimates.

While the meeting did not introduce new information regarding the balance sheet drawdown, officials made a technical adjustment to the rate paid on the reverse repo facility to encourage money market funds and others to transfer cash from the Fed’s books to private markets.

The minutes’ insights into the Fed’s balance sheet come as many anticipate that 2025 may mark the end of the central bank’s holdings reduction, a process known as quantitative tightening (QT).

Having more than doubled its holdings in 2022 via substantial bond purchasing driven by the COVID-19 pandemic, the Fed has been divesting Treasury and mortgage bonds to mitigate excessive liquidity. This has reduced Fed holdings from a peak of $9 trillion to just under $7 trillion.

In this divestment, the Fed aims to stabilize liquidity levels so that money markets can experience normal volatility while the central bank maintains stringent control over the federal funds target rate range, its main instrument for influencing economic momentum.

Before the Fed’s November meeting, major banks indicated to the New York Fed that they expected the QT process to conclude in May, with Fed holdings at approximately $6.375 trillion. This would likely leave bank reserves at $3.125 trillion, higher than the current level of $2.9 trillion.

A significant obstacle for the Fed is the difficulty in determining when too much liquidity has been removed; overshooting can lead to considerable market turmoil, which the Fed aims to avoid by moderating the pace of the balance sheet reduction.

Compounding the Fed’s outlook are ongoing uncertainties regarding government financing needs in the spring, coinciding with Donald Trump’s return to the presidency. Additionally, issues in the private repo market triggered substantial volatility at the end of the third quarter, pushing some banks to utilize the Fed’s Standing Repo Facility for swift cash access.

The minutes highlighted several challenges for the Fed’s balance sheet strategy in the upcoming year. Notably, a resurgence of the government’s borrowing debt limit could complicate the Fed’s evaluation of liquidity conditions. Furthermore, reinstating the debt limit may lead to increased funds flowing into the reverse repo facility as Treasury bill issuance is anticipated to decline.