The Fed’s next move might not be a rate cut–but an end to Quantitative Tightening. Let’s unpack Powell’s latest hint. Important distinctions that you need to know.
KEY TAKEAWAYS
QT removes liquidity by letting securities mature without reinvestment
Powell’s “ample reserves” comment signals QT may be nearing its end
Halting QT would stabilize reserves and short-term yields but not long-term rates
Ending QT isn’t easing–it’s maintaining liquidity
Repo and funding stress are early warning signs the Fed is watching closely
MY HOT TAKES
Powell’s hint wasn’t a pivot–it was plumbing maintenance 🪠
Ending QT is a smart preemptive move to avoid a 2019-style liquidity crunch
The Fed’s still restrictive, but it’s avoiding self-inflicted damage
Markets will cheer, but it’s not stimulus–it’s balance sheet triage
This is about liquidity control, not inflation surrender
You can quote me: “Ending QT isn’t easing; it’s the Fed catching its breath.”
He said what? He–Chairman Powell–said something about “ample reserves.” Was he hinting that there were not enough reserves in the banking system to avoid liquidity challenges? Ok, ok, I will stop beating around the bush and get straight to my point. Powell, in a recent talk at the National Association for Business Economics (NABE) implied that the Fed may be approaching an end to Quantitative Tightening–or QT–in coming months. Now, this is a bit of a tricky topic, and I have written a bit about this in the past. I think, based on Powell’s mention, based on the fact the Wall Street nerd community (of which I am a proud member 🤓) is buzzing, and the fact that the market is THIRSTY for Fed easing, now might be a good time to clarify. I am relatively confident that I now have you completely confused, so I’ll say it plainly: the Fed may abandon its Quantitative Tightening, which was part of its inflation-fighting efforts started back in 2023. Not tightening isn’t easing, but it’s more accommodative than tightening. Let’s unpack all this and see what it may really mean for us.
First, what is quantitative tightening or QT? It is the Fed’s removing liquidity from the system. In its most basic form, the Fed can sell treasuries and mortgage-backed securities from its balance sheet in the open market. A non-Fed buyer in the open market pays cash for the securities and the Fed sends that cash back to the Treasury, essentially removing–actually removing cash from the system. The Fed’s adding supply to the system also pushes yields higher. Higher yields and less liquidity mean that the Fed is pressing on the economic brakes. It is a far-removed cousin from the FOMC changing the Fed Funds target, but it effectively accomplishes the same thing.
Let’s take a step back to a time when the Fed was easing. Most recently, in 2020 when the Fed stepped in to rescue the US economy which was left gasping for air in the wake of rolling COVID shutdowns, the Fed, in addition to pegging Fed Funds at 0%, began quantitative easing (QE), or buying treasuries and mortgage backs in the open market. The opposite of QT, the Fed is paying cash to a non-Fed seller. It is injecting cash into the system and diminishing supply, thus putting downward pressure on yields. Easing–adding logs to the economic fire. Aha, now you remember.
Well, as a result of all that QE and the QE from the Global Financial Crisis, the Fed was left with a rather large portfolio of bonds, referred to as its System Open Market Account (SOMA). The SOMA is part of the Fed’s bigger “balance sheet,” which is often used to refer to its securities holdings, though SOMA is only a subset of the assets on the Fed’s balance sheet. Check out the following chart then keep reading… to get enlightened.
This is a time series chart of the Fed’s SOMA in dollars. You can see how it spiked then expanded in 2020 as the Fed aggressively eased, how it peaked in 2022 then slowly declined through today, where it is still larger than it was prior to the pandemic.
The Fed began to “normalize” policy late last year. It began to lift its foot off the brakes, albeit slowly. It was not stimulating the economy, just slowing it less aggressively–allowing it to run. While the Fed cut the Fed Funds rate, it did not discontinue its QT, which in this case was a "runoff," and not an outright sale of securities in the open market. In other words, that brake was still engaged. Now, we hear that the Fed may end its QT soon. We have to explore this a bit further, because it’s important to understand and place it in context.
When the Fed talks about “runoff,” it is referring to letting bonds mature and roll off its balance sheet. When the Fed holds a Treasury bill or note, that security will eventually mature, and when it does, the Treasury repays the principal. The Fed’s asset disappears, and that payment effectively drains reserves from the banking system. Cash leaves the system and the total reserves available to banks decline. This is how QT tightens liquidity without the Fed ever lifting a finger to sell a single bond. It’s passive tightening. When Powell says the Fed may be nearing the end of QT, he means the runoff may soon stop, not because the Fed has achieved some arbitrary balance sheet size, but because reserves are approaching that fuzzy level the Fed calls “ample.” Ample, as in enough funds to prevent a banking system collapse. 😥
Here’s where it gets interesting. You can’t actually stop a Treasury bill from maturing. Time marches on. So, when people say the Fed will “halt QT,” what they really mean is that the Fed will begin reinvesting the proceeds of maturing securities rather than letting them disappear. In other words, when a bill matures and the Treasury repays the principal, the Fed will take that cash and turn around to buy a new bill. Doing so keeps its total holdings, and the level of reserves in the banking system, roughly constant. It’s not QE, which would mean expanding the balance sheet by buying more than what’s maturing; it’s simply neutral. It halts the tightening, but it doesn’t start easing.
Now, let’s talk about why this matters. The composition of the SOMA portfolio tells us where the pressure is building. Most of the Fed’s holdings are short-dated Treasuries–under five years (see the following chart of SOMA maturities and security types). Nearly half of its Treasury portfolio consists of bills, 2s, 3s, and 5s. There are also longer-term notes and bonds, and of course, a big chunk of mortgage-backed securities (MBS) that are running off painfully slow because almost nobody is refinancing at 7%. This means most of the Fed’s QT has been coming from the short end–bills and shorter notes that mature quickly. The long end, where the 10-year lives, barely moves.
That’s important because when the Fed halts runoff, it will likely choose to reinvest in the short end, like T-bills–not 10s or 30s. Doing so takes pressure off short-term yields and stabilizes the front end of the curve. It helps repo markets, money-market funds, and Treasury bill buyers. But it doesn’t change much for the longer maturities that drive mortgage rates and corporate borrowing costs. In other words, stopping QT will calm the overnight markets and maybe nudge two-year yields lower, but the 10-year yield–the one that sets the tone for mortgages–will remain high as long as inflation expectations, deficits, and global supply of long-term Treasuries stay elevated.
Recently, we’ve seen the first cracks of stress appear in those short-term markets. The effective Fed Funds rate has been hovering near the upper end of the target range, and the overnight repo rate has been climbing. That’s the market whispering to the Fed: “Hey, liquidity is getting tight.” It’s not a full-blown crisis like September 2019, when repo rates suddenly spiked, but it’s a warning shot. And while some of that tension comes from nervous banks holding onto reserves amid recent loan write-downs, 🤔 much of it is mechanical. QT has simply been running long enough to start biting.
When reserves decline, banks become less willing to lend them overnight. They’d rather keep their cash parked at the Fed earning the Interest on Reserve Balances (IORB) than lend to someone who might need it back tomorrow. That hoarding behavior pushes repo rates up and drains market liquidity even faster. Powell’s mention of “ample reserves” signals that the Fed is watching exactly this dynamic–and wants to avoid repeating 2019’s… um, misstep.
So, what happens if the Fed halts runoff? If the Fed begins reinvesting maturing bills, reserves stop falling and the overall size of the balance sheet stabilizes. The supply of short-term Treasuries eases a bit, taking the edge off front-end yields. Repo markets settle, money-market spreads compress, and financial conditions ease, but only slightly. But again, this isn’t stimulus. It’s simply the Fed keeping the pipes from clogging. Think of it as turning off the drain, not turning on the faucet.
Ending QT will almost certainly lead to slightly lower short-term yields. The 5-year and under part of the curve should firm as supply pressure abates. The two-year note might rally modestly, and Treasury bill yields could drift back toward the middle of the Fed Funds target range. That’s healthy and probably overdue. But don’t expect mortgage rates to follow. The Fed’s not buying MBS, and the long end of the curve–the 10 and 30-year–is driven by bigger forces: deficits and inflation expectations. Even if the Fed halts QT tomorrow, those forces keep long yields sticky. So, yes, ending QT will help calm markets and reduce front-end volatility, but it won’t revive the housing market.
Powell’s NABE comments were classic central bank understatement. “We may approach that point in coming months,” he said, referring to the end of QT. That’s code for: “We’re getting close to enough reserves, and we don’t want to break anything.” It’s not a pivot. It’s a plumbing adjustment. The Fed can keep the policy rate restrictive (where it is today at 4.25%) while stabilizing its balance sheet. Those are two different levers, and Powell knows the difference. Ending QT doesn’t mean cutting rates, to be clear. It just means ensuring the system has enough liquidity to operate smoothly.
The Fed’s balance sheet has always been a reflection of crisis and response. It ballooned after 2008, surged again during COVID, and has been shrinking ever since. But every cycle has its endpoint. Ending QT will mark the next phase in that normalization. Really a quiet, technical step that signals stability, not stimulus. So yes, Powell may soon tell his traders at the New York Fed to stop letting the portfolio shrink and to roll maturing bills into new ones. That’s not easing. It’s maintenance.
And while it may bring relief to the front end–lower repo rates and calmer funding markets, it won’t change much for the rest of us. Mortgages will stay expensive, credit spreads won’t vanish, and long-term yields will continue to be at the mercy of bond traders. Still, it matters. Because keeping the financial plumbing running smoothly is what allows everything else to function. So, Powell’s hint about “ample reserves” wasn’t a throwaway line–it was a Powell-esque hint that the Fed is ready to stop tightening the screws. Not easing, not tightening. Just… breathing. Why have I bored you with all these technicalities? Knowledge is power, and you need to be knowledgeable in this market where the Fed’s every word is being examined for traces of market-moving clues.
YESTERDAY’S MARKETS
Stocks rallied hard yesterday, demonstrating how quickly they can come back from Trump’s most recent China threat. Hopes of successful ongoing discussions put wind in the sales of Bulls yesterday, pushing equities higher. High hopes for earnings are getting higher–hopefully equities answer the challenge as we ramp up announcements today. The VIX dropped back below 20 as traders signaled the “all clear.”
NEXT UP
Still NO data today, but lots of earnings to chew on.
Important earnings today: PulteGroup, Northrop Grumman, Halliburton, Danaher, Coca-Cola, RTX, Lockheed, GM, 3M, GE, Philip Morris, Netflix, Mattel, Intuitive Surgical, and Texas Instruments.