The minutes to the January FOMC meeting included a surprising discussion on an early end to balance-sheet rundown (QT). A shift to a proactive risk-management approach raises the risk that the FOMC could pause or end QT at the 19th March meeting. The FOMC tends to move relatively quickly on balance sheet policy once a potential change has been socialized through the minutes. Last year, slowing the pace of QT was discussed in the January meeting minutes, followed by an announcement making this adjustment on 1 May. Given our debt limit baseline (end July or early Aug), we project QT technically can resume in October. But if there are weakening economic indicators along with US equities severely falling by that time, QT might never resume again for the sake of macro -economic stability. We also believe that the level of “ample reserves” has risen significantly in the last 6 years since the Sep’2019 episode of repo pressure. The economy and financial system have grown over the past five years and reserve demand likely increased following the bank stress in March 2023. The Fed also conceives of ample more conservatively than it did during the 2017-2019 QT episode in the sense that it is now not inclined to plumb the very minimum levels of reserves consistent with operating its floor system. The whole point of acting soon is to avoid the roughly $250bn in balance sheet reduction that would occur over the following six months under current QT caps. Once overall QT ends, we expect MBS prepayments to be invested into USTs to facilitate further reduction in the share of MBS in the SOMA portfolio. Along with the likely possibility of SLR relief for UST holdings for G-SIBs, the pause of 6 months in QT implies lower term premium for long end USTs. We maintain that 4.65 is the short-term resistance for 10yr USTs and medium-term range is 4.35-4.65 till economic data or Trump’s tariff events swing it out of the above range. We also believe that QT might not resume in Sep after the pause because by that time, macro-economic stability won’t allow QT to start.
