Federal Reserve pares bond holdings – Easing ends

As the fallout from Jackson Hole continues to spread across markets, investors are keeping their sights set on more drama emanating from the central bank. The Federal Reserve will this week accelerate the pace of its quantitative tightening program (QT). The move is a stark change from the bond buying of the pandemic that saw the central bank almost increase its balance sheet to nearly $9 trillion from $4.2T over the past two years.

A bigger picture: Unlike huge rate hikes announced by the Fed which have been quick to capture the attention of investors, QT is a less transparent way to tighten financial conditions. Be aware that the central bank is not selling its Treasury holdings outright and is instead let them mature and shrink its balance sheet. After a slow beginning, the monthly limits for the sale of Treasuries or mortgage-backed securities will increase to $60B and $35B respectively, as compared to the peak combined rate at $50B in 2017-2019.

Although it’s an intricate accounting procedure that involves redemption caps and settlement windows, it lowers reserves in banks and takes cash from the financial system. After chaos in the repo markets caused the early termination of the QT program in the year of 2019 Certain security measures were put in place including the Standing Repo Facility. The new facility will allow primary dealers to take out more reserves from the Fed against collateral of high-quality However, some experts warn that it may not be enough to stave off liquidity issues, and could interfere with Chair Powell’s plans to increase rates and bring inflation under control.