Buried in a rote US Treasury survey released on the eve of the latest holiday weekend was a question that all of Wall Street wants the answer to: What’s the Federal Reserve’s plan once it’s done drawing down its crisis-era bond holdings?
Fed officials, who are meeting this week, have said very little about the future of the unwind of assets — a process known as quantitative tightening that’s been ongoing since mid-2022 — or their plans for the balance sheet once the runoff has concluded.
Now they are under pressure to provide more insights as banks including Bank of America, Barclays, TD Securities and Goldman Sachs declare the Fed will take longer than they previously anticipated to end QT.
That’s important. The longer the process takes, the greater the chance of draining bank reserves to a point of scarcity and roiling US funding markets. It also increases the threat of boosting borrowing costs as markets struggle to find buyers for new government debt issued to fund the swelling budget deficit.
“You are getting closer to reasonable range of expected stop date, so you probably want to get your questions answered,” said Blake Gwinn, head of US rates strategy at RBC Capital Markets.
The Fed’s guidance matters for the US government, too. The Treasury is expected to adjust the amount of debt to issue and where along the curve it will sell securities — bills or coupon-paying bonds. Those securities offer a global benchmark for trillions of debt, from mortgages to corporate bonds.
In a survey released Jan. 17, Treasury asked primary dealers when they see QT concluding, when the Fed will have to resume buying government debt to maintain ample reserves and what tenors they expect the central bank to buy after QT ends. The next quarterly refunding is due on Feb. 5.
Key to the QT debate is how much more the Fed can shrink its balance sheet before worrisome cracks start to appear as they did in 2019 ahead of an acute funding squeeze that forced the Fed to intervene to stabilize the market.
Powell last referenced QT at the November post-meeting press conference when he compared decisions about slowing the asset runoff to deciding to pause interest-rate cuts. With the Fed widely expected to keep rates on hold Wednesday, that’s heightened focus on any comments on its QT outlook.
So far, the Fed has unwound more than $2 trillion from its balance sheet, leaving about $6.8 trillion in the System Open Market Account, which is well above the pre-Covid levels around $4 trillion. The New York Fed’s primary dealer survey, which it conducts before every policy meeting, showed that in December the median of participants expected QT to end in June 2025 when the central bank’s assets are around $6.38 trillion.
While some strategists have pushed back their initial forecasts, those outlooks are far from unanimous. Some recent intense volatility at month- and quarter-ends, beyond the typical spikes seen at the ends of these periods, have rekindled concern over potential stresses in the financial system.
In addition to the timing and pace of the runoff, the composition of the portfolio is critical for officials planning tenors to target and the potential impact on markets.
Scott Bessent, confirmed Monday as Treasury Secretary in the new administration, has proposed selling more longer-term securities so that less debt comes due in the short term. He was also among Republicans blasting former Secretary Janet Yellen for boosting reliance on short-term bills to fund the deficit.
“This is prudent planning by Treasury to get ahead of issues,” said Guneet Dhingra, head of US interest rates strategy at BNP Paribas. “Treasury has changes to fiscal policy in mind, so is what the Fed going to do be supportive or is it going to be a problem?”
Further clouding the outlook for both Treasury’s near-term issuance and the Fed’s unwind is the reinstatement of the debt ceiling this month. A more drawn out episode will force the government to slash its bill supply and spend down its cash pile. That will artificially boost the central bank’s liabilities, masking money-market signals that could indicate when it’s time to stop QT.
Fed officials have warned — most recently, in the minutes from the last meeting — that the debt limit could make it hard to assess if bank reserves become scarce. Still, the Fed Federal Open Market Committee seems more inclined to keep unwinding SOMA holdings to as little as possible.
“It’s frustrating we haven’t heard much from the FOMC on future SOMA compositions, as if they think QT could go on for meaningfully longer,” said Deutsche Bank strategist Steven Zeng.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
More Outlooks Topics >
