The US Federal Reserve’s balance sheet isn’t just a topic for Wall Street analysts. In 2025, as the Fed continues to shrink its massive holdings, the ripple effects are being felt across global markets—including right here in Australia. If you’re an investor, business owner, or simply interested in what’s shaping our economic outlook, understanding the Fed’s moves is more important than ever.
What Is the Fed Balance Sheet—and Why Is It Shrinking?
At its core, the Federal Reserve’s balance sheet lists all the assets (like US Treasury bonds and mortgage-backed securities) and liabilities (mainly bank reserves and US currency) the central bank holds. During the COVID-19 pandemic, the Fed’s balance sheet ballooned to unprecedented levels—over US$9 trillion at its peak—as it bought assets to stabilise markets and keep borrowing costs low.
But 2025 is a year of contraction. The Fed is now letting billions of dollars in securities mature each month without reinvesting, a process known as quantitative tightening (QT). As of Q2 2025, the balance sheet has dipped below US$7.5 trillion, and there’s speculation about how much further it will go.
- Why the reduction? To combat persistent inflation, the Fed is tightening policy—raising interest rates and reducing its balance sheet—to remove excess liquidity from the financial system.
- Is it working? Inflation in the US is trending closer to the Fed’s 2% target, but global markets remain on edge as liquidity dries up.
How Does the Fed’s Balance Sheet Affect Australian Markets?
The US dollar is the world’s reserve currency, and Fed policy ripples through everything from global share prices to the cost of funding for Aussie banks. Here’s how the current tightening cycle is impacting Australia in 2025:
- Interest Rates: As the Fed tightens, global interest rates rise. The RBA has kept its cash rate at 4.35% through mid-2025, but pressure remains for higher rates as global funding costs increase.
- AUD/USD Exchange Rate: The Australian dollar has faced downward pressure, trading near US$0.62, as investors flock to higher-yielding US assets.
- Stock Market Volatility: ASX investors have seen increased volatility, particularly in sectors sensitive to global funding, like real estate investment trusts (REITs) and tech stocks.
- Property Lending: Australian banks rely on offshore funding, much of it priced off US rates. As global liquidity tightens, borrowing costs for home loans and business finance have ticked higher.
Real-world example: In March 2025, several major Australian banks reported increased wholesale funding costs, citing global liquidity tightening as a key driver. The average variable mortgage rate edged up to 6.2%, despite no change from the RBA.
What Should Australian Investors Watch in 2025?
The Fed’s balance sheet trajectory isn’t set in stone. Markets are closely watching for signs the Fed might pause or slow its quantitative tightening if financial conditions become too restrictive. For Australian investors, this means staying alert to both global signals and local impacts.
- Monitor US Inflation and Fed Statements: Any sign of persistent inflation or sudden financial stress could change the Fed’s pace of QT, swinging global markets.
- Keep an Eye on AUD Volatility: Currency swings can impact the value of offshore investments and the cost of imported goods.
- Diversify Across Asset Classes: With global liquidity shifting, a well-diversified portfolio remains your best defence against unexpected shocks.
- Watch Local Lending Conditions: Rising global rates may continue to feed through to Australian loan rates. Review your debt exposure and consider locking in rates where possible.
2025 also brings unique challenges: geopolitical tensions, shifting commodity prices, and Australia’s own policy settings will all interact with the Fed’s moves. The recent RBA Financial Stability Review highlighted these cross-currents, noting that Australian households are more exposed to global rate shocks than in previous decades.
The Bottom Line: Stay Informed, Stay Flexible
The Fed’s balance sheet reduction in 2025 is a global story with local consequences. For Australians, it means higher borrowing costs, currency volatility, and more challenging investment conditions. But with the right strategy—staying informed, diversifying, and managing risk—you can navigate these shifts and seize opportunities as they arise.
