When the calendar turns to September, the Federal Reserve is about to fill the QT. This is akin to “quantitative tightening,” most recently reversing efforts by central banks to keep money flowing through the U.S. economy during the coronavirus pandemic. This program expanded the Fed’s balance sheet to about $9 trillion. That was easily a record high for scooping up securities made up of US Treasuries and mortgage-backed bonds. This month marks the culmination of QT’s summer expansion, with earnings from maturing bonds reaching up to $95 billion per month, reducing the Fed’s holdings and requiring market participants to make up the shortfall. Balance sheet runoff began in his June. So far, it coincides with a time when Treasury yields have actually fallen net. But since quantitative easing (the market-friendly side of QT) kicked off in 2008, the Fed’s liquidity efforts have acted as a major backstop for the market, raising concerns about unintended consequences. In a recent note to clients, Citigroup economist Isfar Munir said the target pace of rate cuts was “the fastest-ever decline in the Fed’s balance sheet, and the impact on markets is uncertain. It suggests something,” he said. Supply and Demand Issues One of the biggest issues is whether markets will be able to absorb the excess supply created by the Fed’s actions. The Federal Reserve (Fed) already stopped buying Treasuries and mortgage-backed securities earlier this year, and this summer began allowing them to reduce their holdings entirely. At the same time, the central bank has been aggressively raising interest rates, and Treasury bond and bond issuance has slowed amid shrinking government budget deficits. “There are no visible stress points for the rest of the year,” said Lou Crandall, chief economist at Wrightson ICAP. “There is so much excess liquidity that it will take some time before the market is really considered, as opposed to what it looks like going forward.” is the size of its balance sheet. Despite three months of rate cuts, the Fed’s asset portfolio is still just over $8.9 trillion. That’s just $63 billion down from early June. In terms of overall balance sheet size, this tightening is actually smaller than what the Fed did from his 2017 to his 2019. [reduction] Mounir writes: “While such aggressive declines in liquidity suggest we are monitoring market functioning, our base case is that adequate levels of reserves are more important than rapid declines. Depending on how quickly the mortgage-backed securities pay off, the actual total outflow could be closer to $85 billion, Muir added. The question is how far the Fed can push QT before it actually starts to affect market functioning.After all, the last round saw the Fed showing signs of economic weakness and market turmoil. It had to stop after running out of just about $800 billion in the medium term.The housing market is in turmoil as demand has weakened dramatically and mortgage rates have surged. It’s a factor that must be taken into consideration as the economy continues its efforts to slow the rate of inflation, which has produced nearly the fastest inflation rate in more than 20 years. “This was decided months ago.” But he added that the pressing question next year is “to what extent can the Federal Reserve shrink its balance sheet given the demand for liquidity?” Factors in favor of the Fed One of the factors in favor of the Fed is the strong investor demand for safe-haven Treasuries given the recent generally volatile market environment. Despite rising interest rates and the disappearance of the Fed’s backstop, auctions, especially long-term Treasury bonds, have generally been well received. “Investors will still be looking for paper in ways we’re not used to,” said veteran investment banker Christopher Whalen, head of Whalen Global Advisors. “We are used to people issuing paper money and worrying about whether there will be enough demand. [Ginnie Mae notes]So I think yields will go down.” The actual level of mortgage securities on the market could also fall below the $35 billion cap, forcing issuers to offer higher yields as an incentive. yields can be reduced. In fact, MBS Fed holding levels actually rose by about $18 billion in June, but that’s because the late settlement date means the climate is actually giving bonds an edge at a time when stock markets are under pressure. He believes Whalen helps to give “Managers need to get used to the idea that bonds will go up but stocks won’t.” What are you going to do with your asset allocation if you can’t assume that both stocks and bonds will rise?” Markets will struggle to adapt to Fed communications in 2022 after the central bank pivots from its stance of the past two years doing. Warren said of Fed Chairman Jerome Powell, “Powell will stick to his point. I think you will do exactly what you told us to do,” he said.