US: Quantitative easing adjustments that may precede interest rate cuts
2024-01-23
■Since the beginning of the year, the United States has begun to conduct specific research on the adjustment of quantitative easing (Quantitative Tightening, QT)
■To avoid short-term financial market chaos, the preventive adjustment of QT may precede interest rate cuts
Since the beginning of the year, there have been indications that the Federal Reserve Board of the United States (FRB) is considering a revision to the quantitative tightening (QT) of its balance sheet. According to the minutes of the Federal Reserve Open Market Committee (FOMC) meeting released on January 3rd (held on December 12th and 13th last year), the discussion on slowing or stopping QT has been clarified. The President of the Federal Reserve Bank of Dallas mentioned the termination process of QT in his speech on January 6th, which reminded people of the approaching timing of QT adjustment. Before assuming this position, the President of the Federal Reserve Bank of Dallas served as the Vice President of the Federal Reserve Bank of New York, where he was responsible for the operational practices of the System Open Market Account (SOMA), making him an expert in the field of open market operations. He proposed the necessity of QT deceleration and listed specific conditions, which also strengthened people's observation of this possibility.
QT not only absorbs liquidity but also redistributes liquidity (resulting in currency deviation) through changes in the FRB liability structure, which is a factor leading to an increase in short-term financial market interest rates. The President of the Federal Reserve Bank of Dallas pointed out that the sharp increase in guaranteed overnight repo rates (SOFRs) that occurred in early December last year indicates that the entire financial system is no longer in a state of consistently providing sufficient liquidity to all financial institutions. In addition, he warned that during the progress of QT, there may be situations where individual financial institutions fall into funding shortages earlier than the entire financial system. Behind this understanding lies the lesson of 2019. At that time, even during the stage with excess reserves, due to the deviation of funds from individual financial institutions, the short-term repurchase rate in the financial market sharply increased, ultimately forcing FRB to stop QT.
From the perspective of FRB's debt structure, the Overnight Reverse Repurchase Agreement (ONRRP) has been continuously decreasing since mid-2023. ONRRP is a means for FRB to absorb excess liquidity in open market operations, which helps to stabilize and smooth short-term financial markets. The President of the Federal Reserve Bank of Dallas proposed using the ONRRP balance as a measure of QT deceleration and advocated gradually slowing down the speed of QT based on the decrease in ONRRP balance. It is expected that by March 11th, the Bank Term Financing Plan (BTFP) introduced during last year's operational issues in the US banking industry will end as scheduled, which may accelerate the pace of FRB's balance sheet reduction. The QT adjustment is carried out under the consideration of different goals from policy interest rate changes. Given that the incentive for FRB to take preventive measures to slow down the QT to avoid short-term financial market chaos is significant, it can be expected that the QT slowdown may precede interest rate cuts.
■To avoid short-term financial market chaos, the preventive adjustment of QT may precede interest rate cuts
Since the beginning of the year, there have been indications that the Federal Reserve Board of the United States (FRB) is considering a revision to the quantitative tightening (QT) of its balance sheet. According to the minutes of the Federal Reserve Open Market Committee (FOMC) meeting released on January 3rd (held on December 12th and 13th last year), the discussion on slowing or stopping QT has been clarified. The President of the Federal Reserve Bank of Dallas mentioned the termination process of QT in his speech on January 6th, which reminded people of the approaching timing of QT adjustment. Before assuming this position, the President of the Federal Reserve Bank of Dallas served as the Vice President of the Federal Reserve Bank of New York, where he was responsible for the operational practices of the System Open Market Account (SOMA), making him an expert in the field of open market operations. He proposed the necessity of QT deceleration and listed specific conditions, which also strengthened people's observation of this possibility.
QT not only absorbs liquidity but also redistributes liquidity (resulting in currency deviation) through changes in the FRB liability structure, which is a factor leading to an increase in short-term financial market interest rates. The President of the Federal Reserve Bank of Dallas pointed out that the sharp increase in guaranteed overnight repo rates (SOFRs) that occurred in early December last year indicates that the entire financial system is no longer in a state of consistently providing sufficient liquidity to all financial institutions. In addition, he warned that during the progress of QT, there may be situations where individual financial institutions fall into funding shortages earlier than the entire financial system. Behind this understanding lies the lesson of 2019. At that time, even during the stage with excess reserves, due to the deviation of funds from individual financial institutions, the short-term repurchase rate in the financial market sharply increased, ultimately forcing FRB to stop QT.
From the perspective of FRB's debt structure, the Overnight Reverse Repurchase Agreement (ONRRP) has been continuously decreasing since mid-2023. ONRRP is a means for FRB to absorb excess liquidity in open market operations, which helps to stabilize and smooth short-term financial markets. The President of the Federal Reserve Bank of Dallas proposed using the ONRRP balance as a measure of QT deceleration and advocated gradually slowing down the speed of QT based on the decrease in ONRRP balance. It is expected that by March 11th, the Bank Term Financing Plan (BTFP) introduced during last year's operational issues in the US banking industry will end as scheduled, which may accelerate the pace of FRB's balance sheet reduction. The QT adjustment is carried out under the consideration of different goals from policy interest rate changes. Given that the incentive for FRB to take preventive measures to slow down the QT to avoid short-term financial market chaos is significant, it can be expected that the QT slowdown may precede interest rate cuts.