Fed Balance Sheet Is Shrinking Again
It is not certain just what this mean. It could be just a temporary decline, before a possible coming expansion in Treasury holdings. And the absolute level of reserves is certainly still more than enough to fuel money supply expansion. However, because of the Fed's new rule of paying interest on reserves and because of the weak underlying economy, a far higher level of reserves than before will be required to expand money supply. And so, if the trend continues, it could cut monetary expansion short before it has begun to bid up prices outside of the fixed income markets.
So far though, this new trend has only had an impact of the very narrow M1 aggregate. Broader and more relevant aggregates like M2 and MZM continued to expand in the latest report, though it should be noticed that these numbers lag reserve figures by 9 days, as the latest numbers refer to the week ending January 19.
Again, no clear conclusions can be made at this point about what will happen and the main scenario is still that the Fed will continue to inflate, but if (with emphasis on "if") this decline in the Fed balance sheet continues then it will likely start to affect the broader monetary aggregates too.