The Federal Reserve may adjust the pace of tapering as early as the second quarter

As the ON RRP (Overnight Reverse Repurchase) continues to be consumed, the Federal Reserve may intensify discussions on balance sheet reduction in the next two meetings, possibly adjusting the pace of reduction as early as Q2. Compared with rate cuts that have a stronger signaling effect, slowing down balance sheet reduction is more likely to get approval from FOMC members. Moreover, it reduces the risk of instantaneous liquidity shocks and extends the time for monetary policy normalization without necessarily implying a quick shift towards easing; it merely leaves more room for maneuver. In terms of timing, since slowing down balance sheet reduction aims at reducing liquidity risks, signals of declining liquidity need to be observed. We believe that if ON RRP is exhausted in coming months and there are clear signs of reserve decline simultaneously, then there will be an increased necessity to slow down balance sheet reductions. Under fastest circumstances, The Fed might adjust its pace of tapering as soon as Q2.