The Fed's about to try something that almost always has ended in recession

Over the past several months, the Fed has prepared markets for the upcoming effort to reduce the $4.5 trillion it currently holds of mostly Treasurys and mortgage-backed securities. The balance sheet ballooned as the Fed sought to stimulate the economy out of its financial crisis morass.

The Fed has embarked on six such reduction efforts in the past — in 1921-1922, 1928-1930, 1937, 1941, 1948-1950 and 2000.Of those episodes, five ended in recession.

Three rounds of purchases through a program known as quantitative easing or, more colloquially, "money printing," brought the balance sheet to his level. Recently revealed plans show how the Fed will scale back.

Since it began the balance sheet expansion, the Fed has reinvested the proceeds it gets from bonds each month to keep the size stable. In a program that is expected to be announced in September, the Fed will begin letting a specified size roll off each month and reinvest the rest. The roll-off target will be small and increase quarterly until it reaches $50 billion a month.

Current market expectations are that the Fed will keep rolling off proceeds until the balance sheet hits around $2 trillion to $2.5 trillion, a process that could take four or five years. Fed Chair Janet Yellen likes to say the process will be akin to "watching paint dry" and won't be disruptive to markets.

Source: BLoomberg Pro Terminal

Trader Bozhidar Arabadzhiev

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