WisdomTree Minds on the Markets
WisdomTree
Minds on the Markets
WisdomTree
Minds on the Markets
Is There Another Way to Ease without Rate Cuts?
ARCHIVE: Week of February 26, 2024
It is not an understatement to say the markets have been fixated on Fed rate cuts since the December Federal Open Market Committee (FOMC) meeting. Indeed, up until recently, the money and bond markets were pricing in an aggressive rate-cut scenario from Powell & Co. However, economic data released over the first two months of this year have not been overly cooperative with this narrative. As a result, Fed officials have been engaging in definitive pushback on not only when rate cuts could begin but, by extension, the magnitude of any decline in the Fed Funds Rate.
For those optimistic market participants, is all lost, then, on the easing front? No, not at all. First off, the Fed still seems to be inclined to think that rate cuts could occur at some point later this year. In addition, there is another tool of monetary policy that continually flies under the radar, and that comes in the way of the Fed’s balance sheet.
The January FOMC minutes highlighted a policy conversation that Chairman Powell hinted at during his presser; i.e., the Fed will begin to discuss the parameters of reducing the pace of its balance sheet runoff, otherwise known as quantitative tightening (QT).
Let’s do a quick history lesson regarding the Fed’s balance sheet. When stories are written on this topic, what they are actually referring to is the Fed’s holding of primarily Treasury- and mortgage-backed securities (MBS). These line items on the balance sheet are known officially as the System Open Market Account or SOMA.
The COVID-19-related quantitative easing (QE) was historical in nature, as it more than doubled the size of SOMA from just under $4.0 trillion to $8.5 trillion over a two-year period. In other words, the Fed’s current QT program was faced with a “herculean task.” Given the sheer magnitude of this balance sheet expansion, there was no way the policy maker was looking to bring SOMA back down to pre-COVID-19 levels. Rather, the Fed was responding to the need to not only stop adding to its securities holdings but, perhaps more importantly, to begin bringing the absolute level down in an orderly fashion.
Arguably, one could say the Fed has essentially achieved that goal up to this point, as there have been no major dislocations occurring in the funding markets. But, alas, it appears as if the Fed is sensing the time may now be right to pull back on the pace of its balance sheet runoff, with the key variables being how to do it and how to communicate it to the markets. For the record, the Fed has reduced its balance sheet by roughly $1.4 trillion to about $7.1 trillion since QT began in June of last year.
Currently, QT involves reducing its holdings of Treasuries and agency debt/MBS by $60 billion and $35 billion per month, respectively, or $95 billion/month in total. It has been conjectured that perhaps this pace of runoff could be pared back more on the Treasuries side of the equation, as the policy maker has previously stated it would like to get back to having more UST securities and less in the way of MBS on its balance sheet. We would not expect to see an official announcement on this front at the upcoming March FOMC meeting, more so at the May or June convocation, at the latest.
Remember, QT would still be ongoing, just at a reduced pace. While tapering QT is not necessarily a direct form of policy easing, it is another way of taking your foot off the brake.
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