pahueg on Nostr: Explaining the QT dynamicsđđ» So QT is slowed down by 80%, from $25b to $5b. ...
Explaining the QT dynamicsđđ»
So QT is slowed down by 80%, from $25b to $5b. This means that the Fed is slowing down the pace at which it reduces its holdings of U.S. Treasury bonds.
Instead of letting a large amount of bonds roll off its balance sheet each month (which removes money from the financial system), it will now reduce them by only $5 billion per month.
The $20 billion that the Fed was reducing each month but now isnât effectively stays in the financial system.
Said differently: the Fed is reinvesting the remaining $20 billion into new Treasuries, keeping that money circulating in the economy rather than tightening financial conditions.
Why has the Fed decided to taper QT significantly just now?
Well, it has to do with the debt ceiling dynamics. Because the debt ceiling in the United States has not been resolved (might only be resolved in late summer), the US government will most likely have to drain their bank account at the Fed (called TGA).
With TGA falling, liquidity will be pushed into to the financial sector. What the Fed is concerned about is the time, when the debt ceiling is resolved and the TGA will need to be refilled. This will suck liquidity out of the commercial banking syshem. With QT significantly tampered and the Fed reinvesting the proceeds into government bonds, banks will supported and donât have to give up to many reserves for thr refill, helping to avoid any stress in the reserve system.
One of the main drivers is that the Fed wants to avoid another 2019-style repo crisis, rather than having to be reactive and having to perform emergency OMOs all of a sudden.
Hereâs what happened in 2019 as a recap đđ»
September 15, 2019 was a tax deadline, pulling about $100B out of markets as large corporations paid their dues to the IRS and funds flooded into the TGA.
Meanwhile, the Treasury issued new T-Bills to rebuild cash reserves following the post-debt ceiling resolution in August, draining another $50-100B as big banks and institutions absorbed the securities.
During this time, the Fed continued reducing its balance sheet (QT) down to $3.76T, but the balance sheet did not leave enough slack for unexpected cash drains to the system, such as corporate taxes and Treasury issuance.
Also, reserves were largely hoarded by a few of the larger banking institutions due to Liquidity Coverage Ratio (LCR) rules and a higher IOER at 2.1% vs the ON RRP rate of 1.7% - a 40 bp spread.
This caused a liquidity crisis in the US repo market because bank reserves held at the Fed ($1.36T) were too low and repo lending dried up. Banks werenât able to access each otherâs reserves to fund daily operations.
Now, this is what the Fef is avoiding this time around.
Last point on this for now:
As explained already, slowing the runoff of Treasuries reduces the supply in the market, pushing their prices higher (assuming demand remains steady) and lowering yields.
Lower yields mean cheaper borrowing, increasing liquidity as investors seek higher returns in assets like stocks and crypto.
Meanwhile, the Fed maintaining its MBS runoff isnât a major concern for risk assets since MBS (mortgage backef securities) are more directly tied to the housing market, affecting home sales, construction, and refinancing.
While MBS runoff does have indirect effectsâreducing economic activity in housing-related sectors like home improvement retailersâthe impact is more gradual. And we havenât seen that many runoffs because people are in low mortgage rates for long-term and are not refinancing into higher rates.
For risk assets, a drop in the 10-year Treasury yield from 4.3% to 4% has a much bigger influence than a 0.2% rise in mortgage rates due to MBS pressure.
So QT is slowed down by 80%, from $25b to $5b. This means that the Fed is slowing down the pace at which it reduces its holdings of U.S. Treasury bonds.
Instead of letting a large amount of bonds roll off its balance sheet each month (which removes money from the financial system), it will now reduce them by only $5 billion per month.
The $20 billion that the Fed was reducing each month but now isnât effectively stays in the financial system.
Said differently: the Fed is reinvesting the remaining $20 billion into new Treasuries, keeping that money circulating in the economy rather than tightening financial conditions.
Why has the Fed decided to taper QT significantly just now?
Well, it has to do with the debt ceiling dynamics. Because the debt ceiling in the United States has not been resolved (might only be resolved in late summer), the US government will most likely have to drain their bank account at the Fed (called TGA).
With TGA falling, liquidity will be pushed into to the financial sector. What the Fed is concerned about is the time, when the debt ceiling is resolved and the TGA will need to be refilled. This will suck liquidity out of the commercial banking syshem. With QT significantly tampered and the Fed reinvesting the proceeds into government bonds, banks will supported and donât have to give up to many reserves for thr refill, helping to avoid any stress in the reserve system.
One of the main drivers is that the Fed wants to avoid another 2019-style repo crisis, rather than having to be reactive and having to perform emergency OMOs all of a sudden.
Hereâs what happened in 2019 as a recap đđ»
September 15, 2019 was a tax deadline, pulling about $100B out of markets as large corporations paid their dues to the IRS and funds flooded into the TGA.
Meanwhile, the Treasury issued new T-Bills to rebuild cash reserves following the post-debt ceiling resolution in August, draining another $50-100B as big banks and institutions absorbed the securities.
During this time, the Fed continued reducing its balance sheet (QT) down to $3.76T, but the balance sheet did not leave enough slack for unexpected cash drains to the system, such as corporate taxes and Treasury issuance.
Also, reserves were largely hoarded by a few of the larger banking institutions due to Liquidity Coverage Ratio (LCR) rules and a higher IOER at 2.1% vs the ON RRP rate of 1.7% - a 40 bp spread.
This caused a liquidity crisis in the US repo market because bank reserves held at the Fed ($1.36T) were too low and repo lending dried up. Banks werenât able to access each otherâs reserves to fund daily operations.
Now, this is what the Fef is avoiding this time around.
Last point on this for now:
As explained already, slowing the runoff of Treasuries reduces the supply in the market, pushing their prices higher (assuming demand remains steady) and lowering yields.
Lower yields mean cheaper borrowing, increasing liquidity as investors seek higher returns in assets like stocks and crypto.
Meanwhile, the Fed maintaining its MBS runoff isnât a major concern for risk assets since MBS (mortgage backef securities) are more directly tied to the housing market, affecting home sales, construction, and refinancing.
While MBS runoff does have indirect effectsâreducing economic activity in housing-related sectors like home improvement retailersâthe impact is more gradual. And we havenât seen that many runoffs because people are in low mortgage rates for long-term and are not refinancing into higher rates.
For risk assets, a drop in the 10-year Treasury yield from 4.3% to 4% has a much bigger influence than a 0.2% rise in mortgage rates due to MBS pressure.