WSJ Article Review: QT Wind Down

January 15th, 2024

"By slowing the pace at which its balance sheet shrinks, the central bank aims to prevent a messy disruption to the financial system"

"Fed officials are to start deliberations on slowing, though not ending, that so-called quantitative tightening as soon as their policy meeting this month"

“At this point, we are not seeing signs that would indicate that the balance-sheet runoff needs to be slowed right away”

FR Editorial Opinion:

This is repo crisis 2.0. In late 2019, the Fed stopped QT (balance sheet rolloff) and then restarted QE (bond buying) in order to restore order to the reverse purchase agreement market which is an "obscure" part of the banking system as described in the article above.

Clearly, the Fed already has one foot out the door on QT which is currently running at double the pace it was in 2019. However, no timeline or decisions have been made yet. One should assume this will be a very market friendly occurrence when it comes to pass. Particularly for the bond market.

This would all have to take place in 4 phases:

1) FOMC issues timeline

2) QT slows, but does not end

3) QT ends outright

4) QE (bond buying) restarts.

All of the above could take a matter of months depending upon market conditions.

If/when the market crashes and financial conditions markedly tighten, then all of the above four steps will be compressed into one very quick decision.

The high yield spread is a real-time proxy for financial conditions as it tracks the Fed's proprietary "stress index" very closely.