Demystifying Fed Speak: How Shrinking The Balance Sheet Could (Not) Impact Markets

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One of the ways the Fed may tighten financial conditions is by reducing its balance sheet. Here’s what investors should know about it.

At the height of the pandemic, the Fed pumped trillions of dollars into the financial system through asset purchases to support markets and the broader economy. Consequently, its balance sheet ballooned to unprecedented levels, totaling nearly $9 trillion. And it continues to grow. As the Fed considers how it begins to normalize monetary policy, it is likely to begin reducing its balance sheet this year.

Line chart showing the Federal Reserve’s balance sheet since 2002, with the increase commencing during the 2008 financial crisis. At the onset of the pandemic in 2020, the balance sheet increased dramatically to its highest level ever, at nearly $9 trillion.

The Fed has several options for unwinding its portfolio:

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