This stuff is critical for understanding what is fueling the equity market rally. More to come either tomorrow or more probably Monday.
From Wolf Street, December 13:
How far can QT go? Quite a bit further.
When Powell was asked at the post-meeting press conference today about QT while the Fed is cutting rates, it triggered a discussion, which he started out with: “We’re not talking about altering the pace of QT right now, just to get that out of the way.”
The question arose because the Fed said in its policy statement today that QT would continue on autopilot, even as the median projections by FOMC participants saw three rate cuts in 2024. QT has already reduced the balance sheet by $1.2 trillion, and Wall Street hates QT. It wants QT to stop.
And so the hope is that by the first rate cut, the Fed will have ended QT because QT is a mechanism to tighten, while cutting rates is a mechanism to loosen monetary policy, and continuing with QT while cutting rates would bring these two mechanisms into conflict, and that therefore the Fed would stop QT before it starts cutting rates. That’s the hope.
QT while cutting rates.
“They’re on independent tracks,” Powell said. Whether the Fed can keep QT going while also cutting rates, or whether it would end QT before it cuts rates, comes down to why the Fed is cutting rates, he said:
If the Fed is cutting rates in order to go “back to normal,” with the economy growing but inflation low, a scenario that the Fed’s Summary of Economic Projections today projected, the Fed could keep QT going while cutting rates at the same time.
If the Fed is cutting rates because the economy is “really weak,” as Powell put it, the Fed could halt QT while cutting rates.
“So, you can imagine, you have to know what the reason is, to know whether it would be appropriate to do those two things [QT and rate cuts] at the same time,” he said.
How far can the balance sheet drop? RRPs and Reserves.
“The balance sheet seems to be working pretty much as expected,” Powell said. “What we’ve been seeing is that we’re allowing runoff each month. That’s adding up. I think we’re close to $1.2 trillion now. That’s showing up….”
Yes, it is showing up, as we discussed last week:
“The reverse repo facility [RRPs] has been coming down quickly,” he said. “At a certain point, there won’t be any more to come out of, or there will be a level where the reverse repo facility levels out, and at that point, reserves will start to come down.”
With these overnight reserve repos (ON RRPs or short RRPs), which are a liability on the Fed’s balance sheet, not an asset, the Fed takes in cash mostly from money market funds and pays interest of 5.3% (we explained it here).
The balances of RRPs have dropped as money market funds have pulled out their cash and bought Treasury bills with them, of which the government is issuing a huge amount, and which pay more than RRPs, around 5.5% for maturities of four months or less, which are the maturities that money market funds primarily buy.
The normal amounts of ON RRPs is close to zero. Balances surge only under excess liquidity during the latter phases of QE. But then under QT, they drop and go back to their normal state.
That’s what Powell meant when he said, “At a certain point, there won’t be any more to come out of [RRPs because they’ll be at zero], or there will be a level where the reverse repo facility levels out.” Going back down toward the zero line is their normal state:
“And reserves have been either moving up as a result or holding steady,” he said. Reserves or reserve balances are cash that banks put on deposit at the Fed to earn 5.4% interest. They’re a liability on the Fed’s balance sheet, not an asset.
“At a certain point, there won’t be any more to come out of [the RRPs], or there will be a level where the reverse repo facility levels out, and at that point, reserves will start to come down,” he said....
....MUCH MORE
