Roberto Perli on the Past, Present, and Future of the Fed's Balance Sheet

Episode Summary

Executive Summary: Roberto Perli, the New York Fed’s SOMA manager, explains how the Fed is shrinking its balance sheet, why QT has affected term premia, and why the FOMC slowed runoff to avoid an abrupt move from abundant to ample reserves. He argues the Fed’s floor system and ON RRP facility have worked well, with reserves still abundant and the desk using multiple indicators to gauge when to stop QT.

Main Topics: Perli’s background and SOMA role (Priority: 4/5): Perli describes his path from Italy to academia, the private sector, and the New York Fed, then explains his job managing the System Open Market Account, implementing FOMC-directed monetary policy, and briefing the committee on market developments. Fed balance sheet runoff and QT effects (Priority: 5/5): The discussion reviews the post-2022 decline in the Fed’s portfolio, emphasizing that QT has reduced Treasury and MBS holdings while leaving short-term rate control intact and lifting term premia as markets priced a smaller Fed balance sheet. ON RRP as a floor and absorber of runoff (Priority: 5/5): Perli explains that the overnight reverse repo facility sets a floor under short-term rates, has drained as Treasury bill yields rose, and has absorbed nearly all of the balance sheet runoff without pushing reserves lower so far. May FOMC decision to slow QT (Priority: 5/5): He details the committee’s decision to cut the Treasury runoff cap from $60 billion to $25 billion monthly while keeping the MBS cap unchanged, arguing this does not change the end-state but makes the transition to ample reserves more gradual. Indicators for abundant vs. ample reserves (Priority: 5/5): Perli outlines the metrics the desk watches—EFFR-IORB spread, elasticity of the funds rate to reserve shocks, bank borrowing, daylight overdrafts, payment timing, and repo pricing—to detect when reserves are nearing the ample threshold. Why the floor system works (Priority: 4/5): He defends the post-2008 floor operating system as simpler, more stable, and better suited to a world with volatile autonomous liabilities like the TGA, currency, foreign repo pool, and other Fed liabilities. Discount window readiness and reserve demand (Priority: 4/5): Perli says March 2023 underscored the importance of discount window preparedness and that reserve demand appears to have risen structurally due to economic growth, regulation, and stress episodes.

Key Arguments: QT has real effects: as markets anticipated a smaller ultimate Fed balance sheet, term premia increased and rates moved higher. The ON RRP is working as intended by responding endogenously to market rates, especially Treasury bill issuance, and by preventing reserve balances from being drained first. The runoff slowdown is a prudential adjustment, not a policy pivot; it simply allows a more gradual approach to the ample-reserves region. The Fed does not want to repeat the 2019 episode of accidentally moving into scarce reserves, so it is slowing before hitting the ample threshold. The EFFR-IORB spread and the slope/elasticity of reserve demand show the system remains in the flat, abundant region. Reserve demand has likely increased structurally because the economy is larger, regulation encourages higher buffers, and the banking system’s 2023 stress episode raised precautionary demand. The floor system is preferred because it delivers stable rate control, accommodates volatile non-reserve liabilities, and reduces the need for frequent reserve forecasting and open market operations. The standing repo facility reduces uncertainty because market participants now know the Fed can lend on demand during a squeeze, even if sustained use could signal reserves are becoming less abundant.

Data Points: Fed balance sheet reduction since June 2022: More than $1.5 trillion - Total reduction in the Fed’s portfolio over the QT period. Treasury holdings decline: About $1.25 trillion - Approximate reduction in Treasury securities since QT began. MBS holdings decline: About $333 billion - Approximate reduction in mortgage-backed securities since QT began. EFFR position in target range: About 8 basis points above the bottom of the target range - Where the effective federal funds rate has been trading almost every day. ON RRP decline since June of last year: About $1.7 trillion - Drop in ON RRP usage as Treasury bill issuance rose after the debt ceiling suspension. ON RRP current level: $400–$500 billion range - Approximate current size of the ON RRP facility during the interview. Old Treasury runoff cap: $60 billion per month - Treasury securities cap before the May 1 FOMC decision. Old MBS runoff cap: $35 billion per month - Mortgage-backed securities cap, which had not been binding. New Treasury runoff cap: $25 billion per month - Cap set by the May 1 FOMC meeting effective in June. Average MBS runoff: About $16 billion per month - Actual average MBS runoff under the prior regime. New total runoff pace: About $40–$41 billion per month - Combined expected runoff after the May decision. Prior total runoff pace: About $76 billion per month - Combined average portfolio reduction before the pace was slowed. ON RRP decline relative to balance sheet runoff: Roughly equal amounts - Perli says ON RRP absorbed nearly the entirety of the QT runoff so reserves stayed roughly constant. Spread of EFFR to IORB: Negative 7 basis points - Current spread cited as evidence reserves are still abundant. Standing repo facility usage: No utilization outside test transactions - Indicates no current need for the backstop to keep rates in range. March 2023 bank readiness: 90%+ of assets covered - Perli cites Fed data showing substantial discount-window readiness by asset share.

Pivotal Quotes: "The committee thought that slowing the pace of runoff will help ensure the small transition from a regime of abundant reserves to a regime of ample reserves, or closer to ample anyway." — Roberto Perli: Explaining why the FOMC reduced the pace of QT at the May 1 meeting. "I think the floor system maintains interest rate control also at the same time that it allows for policies that significantly expand the Fed balance sheet." — Roberto Perli: Summarizing the key advantage of the Fed’s current operating framework. "It works very well." — Roberto Perli: His concise defense of the Fed’s floor operating system.

Implications: For markets, QT is continuing but at a slower, more cautious pace. The Fed is signaling it wants to avoid reserve scarcity, while the floor system and ON RRP remain central to rate control and financial stability.