NEW YORK (Reuters) -The U.S. Federal Reserve may soon need to grow its balance sheet through bond purchases and could consider shortening the average duration of its debt holdings, Federal Reserve Bank of New York President John Williams said on Friday.

“The next step in our balance sheet strategy will be to assess when the level of reserves has reached ample” from the current state of “somewhat above ample”, Williams said in the text of a speech prepared for delivery at the European Central Bank Conference on Money Markets 2025 in Frankfurt.

When that happens, it will then be time to begin the process of gradual purchases of assets, Williams said.

“Based on recent sustained repo market pressures and other growing signs of reserves moving from abundant to ample, I expect that it will not be long before we reach ample reserves,” Williams added.

SHORTENING AVERAGE DURATION OF DEBT HOLDINGS

At last week’s Fed meeting, the Fed announced that December 1 would bring an effective halt to a three-year-old process to shrink bond holdings acquired as part of an effort to support the economy and financial system during the COVID-19 pandemic.

Williams also made the case for shortening the average duration of the Fed’s government debt holdings since it focused past purchases on long-term bonds and its average duration was now “very long”, much longer than the overall market.

“Having a somewhat neutral or close to neutral maturity structure in a central bank balance sheet relative to what’s out there in the market, it seems to make sense,” Williams said in response to a question. “We’re pretty long right now, very long in duration right now.”

From 2020, the Fed more than doubled the size of its overall holdings to a peak of $9 trillion on aggressive purchases of Treasury and mortgage bonds.

Since 2022, it has been allowing a set amount of those securities to mature and not be replaced with the aim of leaving enough liquidity in the financial system to retain firm control over the federal funds target rate range, its main lever to affect the economy, while at the same time allowing for normal money market volatility.

Recent signs of rising money market rates coupled with active use of Fed liquidity facilities indicated to the Fed it had gone far enough on shrinking holdings, hence its decision to hold the overall balance sheet steady at its current $6.6 trillion level.

Some analysts expect the Fed could start to expand holdings via bond purchases in the first quarter.

Williams cautioned that it’s tricky to know when the Fed has reached the level of reserves that will need it to start putting cash back into the system.

“I am closely monitoring a variety of market indicators related to the fed funds market, repo market, and payments to help assess the state of reserve demand conditions,” he said.

He cautioned that buying bonds to maintain the right amount of liquidity is not stimulus.

“Reserve management purchases will represent the natural next stage of the implementation of the (Federal Open Market Committee’s) ample reserves strategy and in no way represent a change in the underlying stance of monetary policy,” Williams said.

He added that Fed rate control tools like reverse repo and the Standing Repo Facility have been working well, and he expects to see active usage of the latter facility, which lends cash to eligible firms, going forward.