Currently, several Wall Street analysis institutions predict that the Federal Reserve may announce the termination of its multi-year balance sheet reduction plan at the meeting scheduled for the end of this month.
Observers point out that as increased friction in the money market could impact the achievement of the dual mandates of inflation and employment, the Quantitative Tightening (QT) policy is facing a major turning point.
Analysts believe that if the Federal Open Market Committee (FOMC) meeting on October 28-29 stops liquidity withdrawal by ending QT, it would help ensure the smooth operation of the technical aspects of monetary policy.
"We expect the FOMC to terminate the securities reduction plan at this month's meeting," Wrightson ICAP analysts said in a report. Although they are skeptical about whether substantial liquidity stress has already emerged in the money market, the recent volatility in the short-term funding market "clearly constitutes sufficient warning signals to support the Fed moving into the next phase of policy normalization."
Evercore ISI's forecasting team noted on Monday: "We believe the Fed may signal the end of QT at the October meeting, aiming to complete the exit before year-end liquidity pressures arise. However, the actual termination operation might be delayed by one or two months after the official announcement."
Jefferies analysts told clients: "We expect the Fed to fully terminate QT at its next meeting at the end of this month." But they also mentioned that, affected by the sluggish real estate market environment, the reduction process for mortgage-backed securities has always been very slow, and the Fed might still allow these securities to mature naturally at the current pace.
This shift in policy expectations stems from recent market anomalies: several financial institutions unexpectedly utilized the Fed's standing repo facility (which provides quick cash loans to financial institutions using their held bonds as collateral), leading to increases in several key short-term lending rates.
Furthermore, the rise in repo rates and the Secured Overnight Financing Rate (SOFR) also confirms the existence of market friction. Meanwhile, the Fed's core interest rate target—the federal funds rate—has been persistently testing the upper bound of the 4%-4.25% target range.
It is worth noting that these market fluctuations occurred shortly after Fed Chair Powell stated in his speech on October 14 that QT might end "in the coming months." Although he also echoed recent remarks from other Fed officials, stating that the financial system still maintains ample liquidity.
Fed Governor Waller, speaking in New York on Thursday, pointed out that measured by the scale of bank reserves, "we are close to the point where liquidity in the financial system reaches a reasonable level."
QT Process May Draw to a Close
The original intention of the QT plan was to withdraw the liquidity injected into the market during the 2020 COVID-19 pandemic. At that time, to stimulate the economy and stabilize the bond market, the Fed massively purchased U.S. Treasuries and mortgage-backed securities to压低 long-term interest rates.
The bond purchase program launched in the spring of 2020 was so large that it more than doubled the Fed's total asset holdings to $9 trillion by the summer of 2022. Since then, the Fed has reduced its holdings by allowing bonds of a certain size to mature without reinvestment, and the total asset size has now fallen to $6.6 trillion.
The Fed has previously stated that its goal is to maintain ample liquidity within the financial system to effectively control short-term interest rates and cope with normal fluctuations in the money market. However, the challenge facing the Fed is the difficulty in judging "how much liquidity removal would cause market volatility to spiral out of control," making it consistently hard for Wall Street to accurately predict the termination timing of QT.
Jefferies analysts wrote in the report: "The current volatility in the money market is driven by multiple factors, one of which is the Fed's balance sheet reduction policy. Specific reasons include special factors like tax payment dates and Treasury auction settlements, as well as the increased issuance scale of short-term Treasuries; but the primary factor remains the Fed's ongoing balance sheet normalization process."
However, due to the difficulty in precisely determining "the scale of money market liquidity that meets the Fed's standards," some still believe there is room for QT to continue. Especially since bank reserve levels have remained stable, and QT has so far mainly consumed the excess liquidity in the Fed's reverse repo facility. Data shows that although the scale of bank reserves has declined, it has remained near $3 trillion for some time.
Following Powell's speech, Goldman Sachs' forecasting team stated, "We now expect the FOMC to announce at the January meeting next year that the balance sheet reduction plan will terminate in February," significantly earlier than the previous expectation of the end of the first quarter.
