Quantitative Tightening #2

This is 2nd QT Operation; the first began as a passive program in 2015 and ended in 2019, prior to the Covid-19 crisis. The QT program began again in June 2022, through a more active Fed process that involves not just allowing maturing assets to roll off the balance sheet, but to include active asset sales to counter parties. In the past, counter party participants included only primary dealers. That list of participants has grown through the Covid-19 period to include approved municipality and mutual funds.

In the past, when the Fed aimed to reduce its balance sheet through the QT process, the Treasury General Account (TGA) usually had no balance. That is not the case today. In fact, the TGA has ballooned its balance to a more recent level of ~$800bn. In the more recent past (Q4 2018), the Reverse Repo operation was ~$400bn with only limited counter party participation, but that is not the case today either as the Reverse Repo operation has balloone to ~$2.2trn and includes a greater participation to soak up asset sales.

The aforementioned “accounts” above act as liquidity provisions for the financial system. When they increase, liquidity is rising. When they decrease, liquidity is declining or being drained.

As the Fed looks to reduce its balance sheet today (QT2), it will be selling assets to counter parties, for which there are now more to engage than in the previous QT cycle. Additionally and unlike the previous QT cycle, both the Fed’s Reverse Repo operation and the TGA are many times larger. Consider: If the Fed had securities on its balance sheet that matched the maturity profile demanded by the institutions engaging in reverse repos, it could sell an amount equal to the total reverse repo balance to these institutions, reducing the need for reverse repos and elicit no change in the financial or real economy. Consider also: Given that the reverse repo balance is $2.18 trillion, and the Fed is scheduled to reduce its balance sheet by $95 billion per month, it would take almost 2 years to work off reverse repos solely though QT. Plus, the variability of the TGA balance shows that the economy can handle the scheduled liquidity withdrawal, with still yet ample liquidity reserves. From the end of November 2021 to April 2022, the TGA increased by $816 billion. That was equivalent to a QT2 of $163 billion per month, far above the scheduled monthly draw commencing September 2022. Given the balances of the TGA and Reverse Repo operations combined with increased counter party participants and the lesser QT2 operation, mathematically there is no real issue regarding net liquidity drain of the financial economy. (notes from Kevin Muir/Bloomberg)