Fed QT to hit ‘full throttle’ as Central Bank shrinks $9 trillion

(Bloomberg) — The Federal Reserve’s balance sheet easing is set to increase this week, meaning the central bank will finally start unloading the Treasuries it began hoarding nearly three years ago.

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As part of its broader plan to reduce its $9 trillion portfolio, the Fed will tighten monthly caps on the amount of bonds and mortgage-backed securities it will let expire to $60 billion and $35 billion , respectively, using the $326 billion in T-bill stock as backfill when coupons run below the monthly level. September will be the first month the bills will be redeemed as vouchers will fall below the monetary authority’s new cap.

The Fed’s portfolio has $43.6 billion in Treasuries maturing in September, meaning officials will also have to let go of $16.4 billion in bills. It will also need to let another $13.6 billion run in October. These will be the largest reductions for the account portfolio until September 2023.

There has been strong interest in Fed notes due to the fact that the last time the monetary authority undertook so-called quantitative tightening it did not hold any of the securities. It is also critical for money market traders struggling to find assets to invest in. They largely chose to park excess cash in the repurchase agreement facility, and a full review of the Fed’s Treasuries would provide investors with a jolt of supply.

“This is the first time the Fed has allowed the bills to come off their balance sheet, three years after they started buying them quickly because of a lack of reserves,” said TD Securities strategist Gennadiy Goldberg. “QT is in full swing.”

A fall in reserves below the system’s comfortable level in September 2019 helped fuel a disruptive rise in repo rates, a staple of short-term funding markets. As a result, the Fed began buying about $60 billion of Treasuries a month to shore up its reserves — in addition to conducting daily repos.

While the central bank expected to buy bills until the second quarter of 2020, the economic turmoil caused by the pandemic triggered a wave of fiscal and monetary stimulus, flooding the financial system with cash and ensuring that reserves were more than ample. The difference is that the Treasury has since dialed back the amount of the bill supply creating an imbalance where short-term investors are left with very few investment options beyond the Fed’s RRP.

The supply of bills is finally starting to increase, believing that there is still not enough to meet the demand. The expectation among Wall Street strategists is that as the Fed’s pace of rate hikes slows and the Treasury continues to boost the amount of bills it issues, it will pull these wary investors away from RRP heaven and back to Buy. .

However, the week-to-week and month-to-month bond holdings will have no impact on the supply of bonds to the market, as the Treasury has halted purchases in its quarterly borrowing programs, according to Wrightson ICAP. There are longer-term concerns because as the Fed has less debt to lend to dealers in its day-to-day operations, it will hamper their ability to cover negative positions and make borrowing in the repo market more expensive.

“From a cash market perspective, nothing will change when the first settlement of accounts takes place on Thursday,” Wrightson ICAP economist Lou Crandall wrote in a note to clients on Monday.

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