Fed QT planning

Quantitative Tightening… QT is a monetary policy tool that reduces the amount of liquidity in the economy by allowing the securities on the Fed’s balance sheet to reach their maturity. These securities are primarily Treasury bills and mortgage-backed securities. Quantitative tightening (QT) is a contractionary monetary policy tool applied by central banks to reduce the amount of liquidity or money supply in the economy.

When did the Fed start QT? The Fed officially began QT on June 1, after ending its bond purchases in March 2022. Beginning June 1, the Fed began draining this plus $3.3 trillion of bank reserves from its balance sheet of nearly $9 trillion to mobilize all that money. This tightening takes place at a much earlier stage compared to the 2014-2017 model tightening. Following the global financial crisis, the Fed ended its quantitative easing purchases in 2014, but did not begin to shrink its balance sheet until 2017.

Fed funding rate and QT comparison… Source: Reuters

Balance sheet assets… According to New York Fed data, the maturity of the Fed’s Treasury bond portfolio is about two years shorter this time compared to the previous QT round. This is partly due to the significant purchase of T-bills to help restore market stability, especially in the early part of the crisis. T-bills with a maturity of one year or less will be redeemed if the redemption of coupon notes, which are bills and bonds with a maturity of more than one year, falls below the monthly limit. The Fed said it would slow down and then halt the QT process when banking system reserve balances were “slightly above what it judged to be consistent with strong reserves.” In the previous QT cycle, it lowered its reserve levels too much, causing confusion in other short-term funding markets, it doesn’t want to see a repeat of that result.

Comparison of Federal Reserve total money base, money in circulation and reserves… Source: Federal Reserve

Fed’s QT plan… By September, the Fed will cut $60 billion in Treasury bonds and $35 billion in MBS, reducing its assets by $95 billion per month. That’s roughly double the $50 billion monthly maximum rate targeted for the 2017-2019 period. At that time, the breakdown was $30 billion Treasury and $20 billion MBS. In the last cycle, it took a full year for the Fed to reach the maximum cut rate of $50 billion per month. It started with $10 billion ($6 billion Treasury / $4 billion MBS) per month and has increased that by $10 billion per quarter until reaching its maximum rate in the fall of 2018.

This time, it will go from zero to $95 billion over a three-month period, with just one first step before it hits the maximum throttling rate. On June 1, it started the process at $47.5 billion per month for the first three months, after 3 months the deduction amount will increase to $95 billion.

Conclusion? Once the monthly asset decline rate reaches its maximum, it exceeds $1.1 trillion per year in balance sheet reductions. That means it will likely surpass the sum of the entire 2017-2019 QT cycle by early 2023. This corresponds to a balance sheet reduction of approximately 3 trillion dollars in 3 years in total, which is again above the pre-pandemic level. There is a recession approaching, and this risk raises expectations that the Fed may start lowering rates again towards 2024 after the rapid tightening that will include 2023.

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