Citigroup: Powell or take a phased approach to shrink the balance sheet to avoid rekindling tight monetary market conditions.

Citigroup strategist said that Kevin Wash, who has been nominated as the chairman of the Federal Reserve, is likely to gradually reduce the central bank's balance sheet of about $6.6 trillion in assets in a way that avoids reigniting tensions in the money market. Analysis points out that any efforts to restart Quantitative Tightening (QT) may once again put pressure on the $12.6 trillion repurchase market. Citigroup stated that the Federal Reserve paused its balance sheet reduction in December last year because repurchase rates spiked, and this market is a core place where banks engage in short-term borrowing to meet daily liquidity needs. Strategists Alejandra Vazquez Plata and Jason Williams wrote in a report that considering the significant volatility in the repo market last year, the threshold for restarting QT is "very high," and policymakers clearly prefer to avoid a repetition of the tensions in October 2025 and choose a more moderate path for balance sheet management. Wash, a former Federal Reserve Governor, has long advocated for significantly reducing the central bank's financial "footprint." During the global financial crisis and the COVID-19 pandemic, the Fed expanded its balance sheet through multiple rounds of asset purchases, with the balance sheet reaching $8.9 trillion in June 2022, significantly larger than the approximately $800 billion twenty years ago. Late last year, after government borrowing increased and the balance sheet reduction drained market liquidity, the Fed paused its balance sheet reduction and instead started purchasing Treasury securities each month to replenish reserves in the system. However, Citigroup believes that under Wash's leadership, the Fed still has several options for "leveraging down." The least resistant path involves rolling over maturing long-term Treasury bonds into short-term debt to reduce the weighted average maturity of holdings. The strategists also pointed out that Wash may prioritize seeking consensus on interest rate cuts within the committee while gradually advancing balance sheet management. Other optional measures include reducing the current monthly purchase size of Treasury securities of around $400 billion, or even stopping it altogether; or allowing Mortgage-Backed Securities (MBS) to naturally expire. Citigroup's analysis shows that even if the Fed ends purchases as early as June, reserves are unlikely to significantly decrease by December 2026. Their base scenario is to reduce the monthly purchase pace to around $200 billion starting from mid-April and continuing throughout the year. In addition, the Open Market Operations Department of the New York Fed anticipates that reserve management purchases will remain elevated in the coming months to offset a large increase in non-reserve liabilities due to April tax season; thereafter, overall purchase speed may significantly slow down. The minutes from the December Federal Open Market Committee (FOMC) meeting also indicate that participants lean towards concentrating purchases on Treasury securities to gradually align the Fed's asset portfolio towards the structure of outstanding government debt. Citigroup also pointed out that the Treasury Department may be willing to accept additional Treasury securities demand from the Fed, thereby relying more on short-term debt issuances and delaying increases in long-term coupon-bearing bond issuances. Based on this assessment, Citigroup predicts that new issuances of coupon-bearing bonds may start as early as November 2026, with a risk of postponement until February 2027.