personal views of a former fed trader

Tag: quantitative tightening

The QT Timebomb

An aggressive quantitative tightening (“QT”) pace would set the stage for another spike in rates, but this time further out the curve. During QT, the U.S. Treasury increases its borrowing from the private sector to repay Treasuries held by the Fed. While the Fed can be repaid with cash held in either the RRP or banks, the current issuance structure suggests repayment will largely come out of the banking system. The lesson of the prior QT was that reducing the cash balances of banks directly impacts markets that were recipients of that cash. In 2019, banks were pouring their extra cash into the repo market amidst surging demand for repo financing. The repo market broke when QT siphoned that extra cash away. This time around banks have poured their cash into Treasuries and Agency MBS amidst surging issuance. In this post we explain why QT will primarily drain bank cash balances, review the September 2019 repo spike and suggest that the stage is set for a potential spike in longer dated rates.

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Quantitative Tightening Step-by-Step

This post describes the mechanics behind quantitative tightening (“QT”) and reviews the prior QT experience. In our two-tiered monetary system, it is helpful to view QT through a framework that takes into account the perspectives of Banks (those who have a Fed account) and Non-Banks (those who don’t have a Fed account). Mechanically, QT reduces the level of cash held by Banks (reserves) and changes the composition of money held by Non-Banks (more Treasuries and fewer bank deposits). The Fed is unsure how low Bank reserve levels can fall before impacting the financial system, so it executes QT at a measured monthly pace. The prior QT experiment began in late 2017 and ended in September 2019, when a sudden spike in repo rates panicked the Fed into restarting quantitative easing.

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