For the Fed, the impossible QT

The Fed has started shrinking its balance sheet as part of its fight against elevated inflation. However, QT is being challenged by the Fed’s new role as a counterparty of money-market funds. The process would be greatly improved if the Treasury were to announce a debt buyback financed by the issue of T-bills.

As part of its fight against elevated inflation, the Fed has raised its key rates very rapidly in 2022 and in June began to shrink its balance sheet by non-reinvesting a portion of its maturing agency MBS and Treasury securities. As a reminder, the Fed currently holds $2.7tn of MBS and $5.6tn of Treasury securities. One of the motivations behind the process of shrinking the balance sheet, known as ‘quantitative tightening’ (QT), is the fact that the Fed pays an interest rate on some liabilities: the reserves held by commercial banks and the reverse repo agreements, operations under which the Fed borrows overnight, mostly from money-market funds (MMFs).

You can now read the full whitepaper at the link below