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by  BlueBay Fixed Income team Feb 2, 2022

In this short paper by David Riley, Chief Investment Strategist, BlueBay Fixed Income Team, David explores the uncertainties around the path for shrinking the balance sheet – quantitative tightening or ‘QT’ – and the implications in terms of monetary conditions.

  • The US Federal Reserve (Fed) balance sheet is approaching USD 9 trillion in size, equivalent to 36% of US GDP. The FOMC, the Fed’s monetary policy committee, has signalled that it will soon embark on ‘balance sheet normalisation’, starting with the end of large-scale asset purchases (quantitative easing or ‘QE’) in March and then reducing the size of the balance sheet.
  • This note explores the uncertainties around the path for shrinking the balance sheet – quantitative tightening or ‘QT’ – and the implications in terms of monetary conditions.
  • A path for Fed balance sheet reduction starting in July 2022 (announced in March or May), based on a monthly cap on Treasury and MBS redemptions of USD60bn and USD30bn respectively, is modelled. The balance sheet would decline by USD775bn (including maturing T-bills) in 2022, USD 1 trillion in 2023 and USD840bn in 2024 to about 22% of GDP, compared to its pre-pandemic size of 17%.
  • The implied size of balance sheet reduction in 2022 of USD775bn (including T -bills) would be equivalent to a c.20bps increase in the Fed funds rate (c.10bps if T-bills excluded) in 2022 and a cumulative 80bps Fed funds increase over the period to end-2024. In September 2017, the Fed paused its quarterly hiking cycle when it announced the start of QT.

Read the full piece here.

Hear David Riley's recent podcast on Divergent central banks.

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