Today has been set up for a move I have been both expecting and predicting for some time now. I go back a long way on this issue as I wrote a piece for City-AM back in September 2013 suggesting that the Bank of England should start what is now called QT by letting UK government bonds it holds mature without replacement.That would have saved the Bank of England and hence the UK taxpayer quite a lot of money. If we now step forwards nearly a decade I pointed out on July 20th 2023 that there was trouble ahead.
Some market participants think that QT has indeed been an influence on UK bond yields and not in a good way. The issue is that you invariably have several moving parts at once, but I think that you cannot ignore that UK bond yields have got both relatively and historically expensive in the period that Dave is analysing.
This was a response to claims by Bank of England Deputy Governor Dave ( Sir David to his friends) Ramsden who was claiming this.
The empirical evidence we have so far supports the theory: the overall impact of QT on gilt yields appears to have been small.
In their world QE buying caused quite a reduction in bond yields but QT selling had very little effect. As time passed another one of their theories crashed and burned because Bank Rate cuts were combined with bond yield rises. For a while the numbers were matching in that 1% of Bank Rate cuts was met with 1% of UK bond yield rises causing a HAL 9000 moment for fans of 2001 A Space Odyssey.
Many of the factors above were also true for the United States. But there was also another factor as The Donald loomed large. President Trump and his attacks on “Too Late” Powell was if you looked at the detail more upset about higher debt costs and therefore bond yields than the headline rate. That was the road on which I suggested QT was going to be stopped.
Last Week
The pace rather picked up with this.
JP Morgan and Bank of America expect the Fed to halt QT in October. ( @LiveSquawk)
I believe that Goldman Sachs suggest so too.
In addition over the past day or so the “mouth” of Federal Reserve Chair Jerome Powell has been telling us this. From Nick Timiraos in the Wall Street Journal.
Federal Reserve officials have a suddenly pressing decision when they meet this week that has nothing to do with an interest-rate cut. It is whether to stop shrinking the central bank’s $6.6 trillion asset portfolio within days or wait until the end of the year.
You may note that this is a when and not an if. It is an acceleration as on the 15th it was a Paul Simon would put it like a train in the distance according to Federal Reserve Chair Jerome Powell..
Our long-stated plan is to stop balance sheet runoff when reserves are somewhat above the level we judge consistent with ample reserve conditions. We may approach that point in coming months, and we are closely monitoring a wide range of indicators to inform this decision.
As you can see the “months” he spoke of then may well turn out to be days. If so they have lost control of things which were predictable.It is kind of them to make my theme that you should have an exit strategy before you start things like this look so prescient. Or as the Wall Street Journal puts it.
Officials don’t have much experience with the delicate process of shrinking the balance sheet. Like a driver hunting for an off-ramp on an unfamiliar highway, officials risk blowing past the exit if they wait too long.
If this was a football or rather soccer match then the manager would be facing a chorus of “you don’t know what you’re doing”.
Oh and the Nick Timiraos piece has rather a swerve in it. We were previously guided towards QT being the equivalent of an extra rise in interest-rates. Whereas now stopping it “has nothing to do with an interest-rate cut.” For newer readers this is a frequent feature of the way central banking communication is issued and reported.
The Reserves Problem
I have previously looked at this situation with regard to the UK where trouble was expected at around £450 billion of QE and as the range was wide could be in play this year. For newer readers QE changed the money markets creating what you might call its own immortality. Now such factors have rather quickly caught up with the US. We have in the past noted the Reverse Repo situation.
For the past three years, most of the Fed’s balance-sheet runoff drained cash not from banks but from a separate deposit facility where money-market funds could park cash. That facility is nearly empty, having fallen from a peak of more than $2.2 trillion in 2023. With that cushion gone, every dollar that rolls off the Fed’s balance sheet comes straight out of bank reserves. ( Wall Street Journal)
Or as South Park would put it “And it’s gone”. As we know any challenge to “The Precious! The Precious!” has central bankers leaping out of their beds.
Banks have more regularly tapped a Fed lending facility designed as a safety valve that lets them exchange securities for reserves, offering another sign of reserves becoming less ample. ( WSJ)
Also interest-rates have risen.
overnight rates firmed up as the government issued new debt, pulling cash out of the banking system—the government’s equivalent of a big customer making a major withdrawal. Those funding pressures have nudged the central bank’s benchmark federal-funds rate higher within its target range of 4% to 4.25%, which suggests reserves are moving less freely in the banking system. ( WSJ)
Let me give you a reminder of the present state of play.
The Fed is currently allowing up to $35 billion in mortgage securities and $5 billion in Treasurys to roll off the portfolio every month.
Comment
The change in policy was not only perfectly predictable I did so. You may note that I have not mentioned interest-rates so far and the reason is that they are the secondary factor today not the primary one.We have been guided towards another 0.25% reduction, but for me it is really about helping with the issues we have looked at above. In some ways expectations of these moves have been in play as we have seen the US ten-year yield decline below 4%.
But there is rather a large problem here.
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2025 is 3.9 percent on October 27, unchanged from October 16 after rounding.
If economic growth is running at around 1% per quarter as we would record it then that is a level associated in the past with interest-rate rises not cuts. Thus you might introduce QT rather than stop it. Any doubts about the tightening being the correct policy would be rather extinguished by the inflation measure targeted not only being above target but rising from an annual rate of 2.5% to 2.7% over the four months to September.
Added to all of this the succession of stock market highs used to be called “irrational exhuberance” by the Federal Reserve. Or note the rises in price for basic commodities like coffee and copper.
