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Fed lowers balance sheet –

The fallout from Jackson Hole continues to ripple through markets, investors have their sights set on even more drama emanating from the central bank. The Federal Reserve this week is planning to increase the pace of its quantitative tightening (QT) program by ramping up the pace at which it restructures its balance sheet. This is a dramatic change of the bond buying program that was triggered by the pandemic that saw central banks nearly double their balance sheets to almost $9T from $4.2T over the past two years.

Bigger picture: QT is a more opaque method of tightening financial conditions. This contrasts with the Fed’s massive rate hikes that have attracted investor attention. The central bank isn’t selling its Treasury holdings, but rather permitting them to mature in order to reduce its balance sheets. After a few months at a slower pace, monthly caps for offloading Treasuries and mortgage-backed securities are scheduled to increase by $60 billion and $35 billion, respectively, compared to the maximum combined rate of $50B last time the Fed cut its balance sheet between 2017 and 2019.

The whole thing is somewhat of a complicated accounting process which involves settlement windows as well as redemption caps but at a more basic level, it reduces the supply of bank reserves and drains funds from the financial system. After the chaos in the repo market caused the abrupt termination of the QT program in the year of 2019 Some precautions were taken including the Standing Repo Facility. The new facility will allow primary dealers to borrow more money from the Fed against high quality collateral. However, it’s important to keep in mind that it might not be enough to end liquidity problems and could hinder Chair Powell’s plans to raise rates and bringing down inflation.

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