The Fed’s QT Quantitative Tightening continues as inflation remains elevated and could even keep rising as WTI crude oil prices hit an all-year high at nearly 90 USD a barrel.
The Fed has already reduced 24% of the Treasury securities it had added during pandemic QE.
Moreover, the Fed’s QT liquidity unwind from the bank bailouts in March continued: The Fed’s total assets fell by $105 billion in August, and by $864 billion since peak QE in April 2022, to $8.10 trillion, which is the lowest since July 2021, according to the Fed’s weekly balance sheet today.
If the Fed’s pace of QT continues the central bank’s total assets will fall below $8 trillion in October
Post the regional bank runs in March, the Fed has reduced its assets by $632 billion, as QT continued uninterrupted on the same track as before the panic, and as the bank liquidity support measures got unwound.
QT2 continues, but how does it compare with QT1
In QT1, between November 2017 and August 2019, total assets dropped by $688 billion. QT2 started in the summer of 2022, and has already reached $864 billion.
But relative to the Fed’s balance sheet expansion over the last 5 years QT2 could still have more to go.
QT2 continues as inflation is way above the Fed’s 2% target
The difference between QT1 and QT2 is that in the latter case, inflation is more than the Fed target, and during Q1, inflation was below the Fed’s target.
Treasury securities: -$59.5 billion in August, -$783 billion from the peak in June 2022, to $4.99 trillion, the lowest since April 2021.
Treasury notes and bonds “roll off” the balance sheet mid-month or at the end of the month when they mature and the Fed gets paid face value for them.
If the Fed QT continues, what does it mean for treasury yields and interest rates?
If investors are shying away from treasuries because they believe the supply of treasuries will increase the demand for the bond, the price of the treasury will fall, and their corresponding yields will go higher.
The fact that the Fed’s QT continues indicates that monetary policymakers are okay with rising yields.
But rising treasury yields also increase borrowing costs domestically and globally, bearing in mind USD is a reserve currency.
So restrictive monetary policy is likely to continue for longer than anticipated.
QT continues; more pain for banks
If the buyer of last resort, the Fed, steps back from buying the slack in treasuries, bond prices could keep falling and that could worsen the bank liquidity crisis.
Banks are not making loans as they try to repair their balance sheet.
Banks are already feeling the pain of holding long-maturity treasuries in an inflationary environment.
So it is no surprise that Banks’ usage of emergency funds jumps to new record highs. Money is now tight for everyone.