Frequent signals of "tight money" Wall Street is confident that the Federal Reserve will signal the end of balance sheet reduction this month

According to the Zhitong Finance APP, multiple Wall Street analysis institutions predict that the Federal Reserve may announce the termination of its years-long balance sheet reduction plan at the meeting scheduled for the end of this month.

Observers point out that due to increasing friction in the money market, which may affect the achievement of the dual goals of inflation and employment, the quantitative tightening (QT) policy is facing a significant turning point.

Analysts believe that if the QT is terminated to stop liquidity withdrawal at the Federal Open Market Committee (FOMC) meeting on October 28-29, it will help ensure the smooth operation of monetary policy at a technical level.

"We expect the FOMC to terminate the securities reduction plan at this month's meeting," said Wrightson ICAP analysts in a report. Although they are skeptical about whether there has been substantial liquidity tension in the money market, the recent volatility in the short-term financing market "clearly constitutes a sufficient warning signal to support the Fed entering the next stage of policy normalization."

The forecasting team at Evercore ISI pointed out on Monday: "We believe the Fed may signal the end of QT at the October meeting in order to complete the exit before year-end liquidity pressures arise. However, the actual termination may be delayed by one or two months after the official announcement."

Jefferies analysts told clients: "We expect the Fed to completely terminate QT at the next meeting at the end of this month." However, they also mentioned that due to the sluggish environment in the real estate market, the reduction process of mortgage-backed securities has been very slow, and the Fed may still allow these securities to mature naturally at the current pace.

This shift in policy expectations stems from recent market fluctuations: several financial institutions unexpectedly utilized the Fed's standing repo facility (which provides quick cash loans to financial institutions against collateralized bonds), leading to increases in several key short-term borrowing rates.

Additionally, the rise in repo rates and the secured overnight financing rate (SOFR) also confirms the existence of market friction. Meanwhile, the Fed's core interest rate target—the federal funds rate—has continued to rise within the 4%-4.25% target range.

It is noteworthy that during the time of these market fluctuations, Fed Chairman Powell stated in a speech on October 14 that QT may end "in the coming months." Although he echoed recent statements from other Fed officials, stating that the financial system still retains ample liquidity.

Fed Governor Waller pointed out in a speech in New York on Thursday that, measured by the size of bank reserves, "we are nearing the point where liquidity in the financial system reaches a reasonable level."

QT Process May Come to an End

The original intention of the QT plan was to withdraw the liquidity injected into the market during the COVID-19 pandemic in 2020. At that time, to stimulate the economy and stabilize the bond market, the Fed made large-scale purchases of U.S. Treasury bonds and mortgage-backed securities to lower long-term interest rates.

This round of bond purchases, which began in the spring of 2020, was massive, causing the Fed's total asset holdings to increase to $9 trillion by the summer of 2022, more than doubling from previous levels. Since then, the Fed has reduced its holdings by allowing a specific amount of bonds to mature without reinvestment, and the current total asset size has decreased to $6.6 trillion

The Federal Reserve previously stated that its goal is to maintain ample liquidity in the financial system to effectively control short-term interest rates and respond to normal fluctuations in the money market. However, the challenge facing the Federal Reserve is the difficulty in determining "how much liquidity removal will lead to uncontrolled market volatility," making it difficult for Wall Street to accurately predict the end date of quantitative tightening (QT).

Analysts at Jefferies wrote in a report: "The current fluctuations in the money market are driven by multiple factors, one of which is the Federal Reserve's balance sheet reduction policy. Specific reasons include special factors such as tax payment dates and Treasury auction settlements, as well as the expansion of short-term Treasury issuance; however, the main factor remains the Federal Reserve's ongoing process of normalizing its balance sheet."

However, due to the difficulty in accurately determining "the scale of money market liquidity that meets the Federal Reserve's standards," there are still views that QT may have room for continuation. Especially since the current level of bank reserves remains stable, and QT has mainly consumed excess liquidity from the Federal Reserve's reverse repurchase tool to date. Data shows that while the scale of bank reserves has declined, it has remained close to $3 trillion for some time.

Goldman Sachs' forecasting team stated after Powell's speech, "We now expect the FOMC to announce that the balance sheet reduction plan will end in February at the January meeting," which is significantly earlier than the previous expectation of the end of the first quarter