Fed’s QT Fears

The Fed’s QT fears of selling more assets without sending asset prices into a tailspin were revealed in the latest FOMC minutes.

Quantitative tightening QT1 blows up the Repo market and forces the Fed to abandon its asset sales. 

The Fed selling assets is akin to a giant straw, sucking up liquidity from the market. An illiquid market means the level of liquidity is too low to support asset buying at current prices, which leads to lower asset prices. 

Fed’s QT fears in leveraged markets 

QT is particularly problematic in leveraged markets

Low asset prices can lead to further forced selling as traders’ positions are liquidated due to the dreaded margin calls.

So, the Fed’s QT could trigger a tsunami of forced selling margin calls, leading to a spectacular asset price crash.

Think about it. If you are a forced seller in an illiquid market, then you will get fleeced. 

Fed's QT Fears

In a zero-sum game, another trader on the other side of the trade eagerly buys quality assets at bargain basement prices.

QT has already reduced the Fed’s balance sheet by 1.34 trillion US dollars   

“The FOMC voted unanimously today to maintain its five policy rates, with the top of its policy rates at 5.50%, as had been broadly telegraphed in recent weeks in speeches, interviews, and panel discussions by Fed governors in their efforts to push back against the rate-cut mania that had broken out in early November last year. The last rate hike occurred at its meeting in July.

The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 per cent.”

The Fed’s QT fears of breaking something are less worrisome than inflation

 “In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 per cent objective.”

So the Fed QT continues, which consists of $60 billion per month of treasury roll-offs and MBS roll-offs capped at $35 billion per month as per plan.

The Fed has already sold 1.3 trillion dollars of assets in its QT monetary tightening policy, which it started in July 2022. 

Where are the Fed’s QT fears 

“The U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.” 

The five known bank failures in 2023 were triggered by the treasury bond market blow up. 

Moreover, the Fed selling $60 billion per month of the treasury roll-offs could have been the straw that broke the camel’s back.

QT cycle over and at the beginning of a secular bull market? 

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