The Federal Open Market Committee is expected to begin the process of reducing the Fed’s balance sheet. Here’s what it may mean for investors.

Following the financial crisis, the Federal Reserve purchased bonds as a way to stimulate the economy. Then Fed Chair Ben Bernanke explained the intent of this policy, known as quantitative easing, in 2010:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.” 1

But the Fed is now ready for a return to more normal monetary policy. At the Federal Open Market Committee (FOMC) meeting in June 2017, the Fed announced a strategy to reduce the size of its balance sheet by letting the bonds mature, a process called balance sheet normalization. And at a subsequent meeting in July, the Fed said it plans to begin this process relatively soon. Given the recent commentary from Fed officials, we expect this process to kick off at the September FOMC meeting.

It remains to be seen how this change will affect markets. Patrick Harker, president of the Federal Reserve Bank of Philadelphia, described it as the policy equivalent of watching paint dry.2 But we suspect that the effect it could have on markets may not be so boring.

The Fed grew its balance sheet by purchasing primarily U.S. Treasury bonds and mortgage-backed securities. Now, it plans for its balance sheet to decline at a rate no faster than $50 billion per month. This equates to a decline of $600 billion per year.

Growth and projected decline of the Fed’s balance sheet

Source: Federal Reserve and Columbia Threadneedle Investments as of June 30, 2017.

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