The Federal Reserve, led by Jay Powell, officially began its Quantitative Tightening (QT) measures on June 1, 2022. At that juncture, the Fed’s balance sheet had risen to a staggering $8.9 trillion, while consumer price inflation was approaching a 40-year high.
“Brace yourself,” advised Jamie Dimon, CEO of JPMorgan Chase.
The strategic plan entailed the Fed reducing its holdings of Treasuries and mortgage-backed securities by a combined $47.5 billion monthly during the initial three months. Subsequently, in September 2022, this monthly reduction was increased to $95 billion—$60 billion in Treasuries and $35 billion in mortgage-backed securities.
Barring a sudden $400 billion increase in March 2023, following the rapid failures of Silicon Valley Bank, Signature Bank, and First Republic Bank, QT has proceeded as intended. Presently, the Fed’s balance sheet stands just below $7.7 trillion.
The next Federal Open Market Committee (FOMC) meeting is scheduled for January 30 and 31, where whispers from the Wall Street Journal suggest the Fed may be reconsidering its course of action:
“Fed officials are beginning discussions on slowing, though not halting, the so-called quantitative tightening as early as their policy meeting this month. This could carry significant implications for financial markets.”
“The Fed can reduce its holdings by selling bonds or, as has been preferred, allowing bonds to naturally mature and leave its balance sheet without reinvestment. This ‘runoff’ increases the availability of bonds that investors must absorb, thereby exerting upward pressure on long-term interest rates. Reducing the runoff can alleviate that upward pressure.”
Currently, the Fed has only managed to trim about $1.2 trillion from its substantial stockpile of assets. It remains far from achieving the pre-COVID level of approximately $4 trillion, let alone the $900 billion seen before the Great Recession.
Given the likelihood of a tapering of QT in the coming months, returning the balance sheet to its January 2020 status appears improbable.
So, what does this mean?
Unconscious Biases
Reversing the extensive money printing spree from 2020-22 has never seemed like a feasible task. Historical evidence suggests that the Fed has struggled to eliminate reserves added during the 2008-13 money printing phase.
John Maynard Keynes, a key figure of modern economic thought, articulated in his 1935 work, The General Theory of Employment, Interest and Money:
“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
In November 2008, Fed Chair Ben Bernanke made impactful decisions that ultimately compromised American savers and workers. He could not resist the pull of his biases.
Peering into history, Bernanke, an esteemed scholar of the Great Depression, drew unsettling parallels between the economic climate of 2008 and the early 1930s, leading him to preemptively inflate the money supply.
He started the quantitative easing (QE) program by acquiring $600 billion in mortgage-backed securities and Treasuries using newly created digital currency, primarily to assist major Wall Street banks.
Pro-QE, Anti-QT
By March 2009, Bernanke had dramatically increased the Fed’s balance sheet from $900 billion to $1.75 trillion, eventually reaching $4.5 trillion over five years—all while claiming he was warding off another Great Depression.
Did it never occur to him that such market interventions might hinder necessary financial corrections? Or that these actions could distort the economy further and pave the way for a more significant crisis?
It is likely Bernanke understood the ramifications. The Fed is, after all, aligned with the interests of big banks rather than those of everyday citizens.
When it came time to implement corrections, Bernanke had departed, leaving Janet Yellen, who served as Fed Chair from 2014 until 2018, to manage the contraction of the $4.5 trillion balance sheet eight years post-Great Recession.
Jamie Dimon, a prominent banker, expressed apprehensions about QT. Both in 2022 and earlier in 2017, he cautioned about the potential disruptions that might arise from unwinding such extensive QE.
“We’ve never had QE like this before, we’ve never had unwinding like this before. Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before,” he noted during a conference.
Yellen, however, was confident in her strategy…
Yellen’s Epic Fail
On September 20, 2017, as the Fed prepared for QT, Yellen outlined a framework for how it would be implemented in a statement following the FOMC meeting.
The statement indicated a kickoff of the balance sheet normalization process in October. The accompanying implementation note detailed the methodology for contracting the Fed’s balance sheet:
“Beginning in October 2017, the Committee directs the [Open Market] Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $6 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $4 billion.”
Moreover, in the Fed’s June 2017 Addendum to the Policy Normalization Principles and Plans, plans were laid out to gradually increase this initial contraction up to $50 billion per month.
Calculating the timeline, had the initial October 2017 reduction commenced at $10 billion and increased quarterly until reaching $50 billion, it would have taken about 78 months to reduce the Fed’s balance sheet back to $900 billion—roughly pre-Bernanke levels—and returning to monetary policy normalcy by March 2024.
Yet, Yellen’s “master plan” failed spectacularly.
As it stands, the Fed’s balance sheet is approximately $7.7 trillion—not $900 billion—leaving significant disruption in its wake.
Fed’s QT Taper Talks Are Already Behind The Eight Ball
The QT initiative was abruptly halted and reversed in September 2019—just 24 months after it began—when the Fed’s balance sheet stood at $3.7 trillion. This reversal was originally triggered to restore liquidity during a period of turmoil in short-term funding markets.
If you recall, in mid-September 2019, the overnight repurchase agreement (repo) rate surged to 10 percent, leading to a breakdown in short-term liquidity markets. The Fed responded by injecting hundreds of billions into the market nightly to maintain stability.
This situation prompted the Fed’s subsequent aggressive monetary response, ballooning the balance sheet by $5 trillion during the COVID-19 panic between March and June 2020.
Chair Powell, however, is perceived as much more astute than Yellen. He utilizes his sixth sense to gauge the reserves in the market, aiming to avert a repeat of liquidity crises like the one in 2019. Returning to the Wall Street Journal:
“While the Fed anticipates reducing short-term interest rates this year due to declining inflation, the rationale for tapering the bond runoff is primarily to prevent disruption in those critical segments of the financial markets.”
“Five years ago, balance-sheet runoff resulted in upheavals, leading to an embarrassing reversal. Officials are determined to avoid a repeat.”
In essence, the Fed aims to adjust its actions proactively to avoid market panic—unlike what transpired in September 2019. Yet, is the Fed misjudging the timing of the impending liquidity crisis?
“Generals are always prepared to fight the last war,” an age-old saying reminds us.
The landscape of monetary policy has shifted considerably over the past five years. As March nears, the Fed’s Bank Term Funding Program (BTFP) is set to conclude. This, combined with the swift depletion of reserves, indicates that the Fed’s tapering plans for QT may already be lagging behind.
Another liquidity crisis, stemming from the Fed’s own actions, may soon be upon us.
[Editor’s note: You may not realize this, but economic recessions can be opportune times for wealth creation. >> Here’s how.]
Sincerely,
MN Gordon
for Economic Prism
Return from Fed’s QT Taper Talks Are Already Behind The Eight Ball to Economic Prism
