Author |Dai Xianfeng.
Overseas macro hedging manager, understand APP expert.
PS: The views in this article are for readers' reference only and do not constitute personal investment advice, and investors should make their own judgments and bear risks based on their own circumstances.
a.Summary. The beginning of the end of QT (quantitative tightening) is at the level of discussion. The market is starting to talk about it. The Fed is starting to talk about this. This is starting to be discussed between the market and the Fed.
In response to a reporter's question, Powell said that the Fed talked about the "balance sheet" at its January meeting, and that it will be discussed in further depth in March.
As a result, the Fed is likely to start tapering QT in May or June.
Tapering of QT is within the Fed's control. They also don't have to think in detail about indicators such as "sufficient" reserves. They just have to make a decision.
When to end QT is more difficult.
Based on some of my assumptions, the Fed can end QT in two months (May 2024) to eight months (October 2024). My assumptions include the assumption that the Fed's balance sheet reduction will immediately lead to a decline in reserve balances.
Alternatively, based on reverse repo (RRP) flows, the Fed could end QT in about 5 months (August 2024). The assumption is that the depletion of RRP indicates that reserves have fallen to an "adequate" level (not "excessively sufficient").
Assuming that the RRP runs out at an average rate in 2023, it will run out in five months.
In reality, there are uncertainties in these assumptions.
The pace of decline in reserves is largely out of the Fed's control and depends on external institutions: banks and non-banks (GSEs, money markets**, and the U.S. Treasury).
RRP churn is based on perceived risk and return market decisions, which are difficult to ** in the short term.
The ideal level of reserves is also vague.
Based on the experience of the last balance sheet reduction, the 7% level of GDP seems to be the lower bound. At that time, at this level, banks began to be reluctant to tap into their own reserves, which were not "sufficient" and money market interest rates soared.
Therefore, this time the Fed may want to keep the reserve ratio above 7% of GDP. Fed economists give estimates of between 10% and 12% of GDP.
All things considered, it seems realistic for the Fed to end QT closer to around the end of 2024.
It could even end its balance sheet reduction in October 2024.
Regardless of the point in time when QT is curtailed or ended, this will provide further support to the market.
b.The QT of the two times is very different.
There is a significant difference between the previous QT (QT1) and the current QT (QT2).
Qt1 leads to a direct reduction in the quasi-principal.
In Qt2, although the Fed's balance sheet shrank by 1$3 trillion, but the Fed's reserves have increased slightly.
The Fed launched QT1 in October 2017 and ended it in August 2019. The Fed's balance sheet shrank by $682 billion, or 153%。
Qt2 So far, the Fed's balance sheet has shrunk by 1$3 trillion, a decrease of 146%。
There is a significant difference in the level of reserves between Qt1 and Qt2.
The reserve ratio in Qt1 fell by $709 billion, almost exactly in line with the shrinkage of the balance sheet. However, there was a slight increase in QT2 provisions, which increased by US$234 billion.
c.Changes in the structure of the Fed's balance sheet are the reason.
Behind the difference between Qt1 and Qt2 is a change in the composition of the Fed's balance sheet.
The composition of the Fed's balance sheet has changed dramatically since the pandemic. Non-bank institutions (GSE, MMF, and the U.S. Treasury Department) are beginning to play an important role. There are considerable balances in both the reserve requirement ratio and the TGA – the Fed has entered a "abundant" reserve regime.
At Q1, RRP (reverse repo) and TGA account balances are negligible.
At QT2, RRP and TGA became major components of the Fed's balance sheet and began to have a significant impact. In Qt2, RRP is down, not reserves.
RRP also interacts dynamically with the TGA, reacting based on the availability and attractiveness of Treasury bills.
When the TGA balance decreases in 2021 and 2023, the RRP balance increases. When the Treasury issued notes and increased the TGA balance, the RRP balance fell since the MMF purchased the notes.
d.The Fed could begin tapering QT in May or June 2024
The timing of the Fed's QT cuts is easier to measure.
If the Fed starts "deep discussions" about cutting QT in March, it will likely be implemented in the month.
e.The Fed could end QT around October 2024
The Fed has given some vague guidance on how to view the Fed's balance sheet:
.The Committee intends to maintain the ** holdings required for the effective and efficient implementation of monetary policy under its abundant reserve system. ”
Fed economists estimate "adequate" reserves at between 10% and 12% of GDP.
On this basis, I calculated some of the dates when the Fed might end the QT interval.
I also assume that since RRP is now very low, a contraction in the Fed's balance sheet would lead to a similar decline in the reserve ratio. I also assume that the Fed's balance sheet reduction will remain at $100 billion.
Assuming that the Fed targets a quasi-principal of 12% of GDP, it may end QT in two months (May).
Assuming the Fed targets a level of 10% of GDP in reserves, it will take 8 months to achieve that. As a result, the Fed may end QT in October 2024.
In fact, since the RRP has not yet been depleted and the Fed will gradually reduce its reserves, the reserve ratio may not fall immediately.
It may be more realistic for the Fed to end QT in October 2024 or sometime near the end of 2024.
I then assume that RRP depletion indicates that reserves have reached an "adequate" level.
In this case, the RRP will be exhausted in five months.
As a result, the Fed may end QT in August 2024.
f.Conclusion. The Fed is discussing a QT cut, and a QT cut could happen soon, possibly in May or June 2024.
The end of Qt may be near the end of 2024, or October 2024.
In any case, a reduction in QT or a termination of QT could provide further support to the market.