By Howard Schneider

WASHINGTON (Reuters) – As part of its battle against inflation and a return to more normal monetary policy, the U.S. Federal Reserve is approaching a decision to reduce its balance sheet, https://graphics.reuters.com/USA-FED/BALANCESHEET/byprjmwezpe/index.html which has roughly doubled in size during the pandemic to nearly $9 trillion.

The stockpile is huge and has helped lower long-term interest rates, including mortgage rates. This affects many asset and other prices.

The long road to reach a large balance sheet has been long. It will take a lot of work to get to the level that is considered “normal”.

The Fed had a small but steady presence on the government bond and stock markets for most of its history. This changed when “quantitative ease” was introduced by the Fed in 2007. It involves the purchasing of large quantities of debt to channel cash into the financial sector.

Since then, the balance sheet has changed in different stages. Officials are now opening the next chapter to discuss how quickly they should pull out of the main markets for U.S. Treasury Bonds and Mortgage-backed Securities.

Along with Fed plans of raising its short term policy rate, this prospect is prompting financial markets and other market players to revise the rates at which households, companies, and the government borrow money.

Rising rates https://graphics.reuters.com/USA-FED/RATES/zgpomaxjqpd/chart.png

The policymakers aren’t yet deciding how quickly to draw down the money. Jerome Powell (Federal Chair) has indicated that they would accelerate, but the final destination is not yet clear. Last time that the Fed tried “quantitative tightening”, it took a maximum $50 billion per month from the financial sector.

Analysts continue to pencil in greater numbers. Kathy Bostjancic, Oxford Economics Chief U.S. Financial Market Economist, anticipates a pace of $90 billion per monthly.

“The financial system can tolerate an accelerated reduction in the Fed’s holdings of securities,” with perhaps $1.8 trillion of “excess liquidity” sloshing through the financial plumbing, she wrote this week. We expect the Fed to act aggressively.