![]() The second source of additional supply is QT. While the deficit will shrink a little this year compared to last, the Congressional Budget Office says the trajectory is basically a trillion dollars a year of Treasury issuance for the foreseeable future. One, there are the budget deficits the U.S. ![]() Market pricing is determined by supply and demand, and in the coming years, there is going to be a tremendous supply of Treasuries coming from two sources. This is happening at a time when Treasury issuance is high. QT also reverses the risk-on effect of QE, which occurred when many investors looking for yield moved into riskier assets or longer-dated Treasury bonds. There is the portfolio-rebalancing impact, whereby losses on the bond side of a portfolio would prompt an investor to sell some equities to rebalance. Higher yields affect equities in a few ways. We will likely see higher fixed-income yields. Markets haven’t priced in just what that means. When you’re increasing the supply of bonds into a market that isn’t very liquid, and when the marginal buyer is changing as the Fed steps back, you’re going to get volatility. The Fed receives that cash and then simply cancels it-the opposite of what happened during QE, when the Fed created cash out of thin air. Treasury issues new debt to an investor and uses the issuance proceeds to repay the Treasuries held by the Fed. QT increases the amount of Treasuries available to investors while also reducing their cash holdings. Now the Fed wants to tighten financial conditions. Joseph Wang: When the economy wasn’t doing well, QE put downward pressure on interest rates and increased liquidity in the financial system. Wang explains what’s at stake in the edited conversation that follows.īarron’s: How will quantitative tightening unfold, and how will accelerated redemptions affect the market? What could go wrong? Potentially, a lot, suggests Joseph Wang, a former trader on the Fed’s open-market desk and author of the Fed Guy blog and Central Banking 101. At full-throttle, the pace of balance-sheet tightening will be much more aggressive than in the past, and come at a time when interest rates are rising quickly. QT is as ambitious as its impact is uncertain. 15, as Treasuries are redeemed midmonth and at the end of the month. The amount will double this month and effectively kicks in Sept. In June, the central bank started to shrink its portfolio by letting up to $30 billion of Treasuries and $17.5 billion of mortgage-backed securities, or MBS, roll off its balance sheet, or mature without reinvesting the proceeds. Now, with inflation rampant, the Fed is unwinding this liquidity via a process known as quantitative tightening, or QT. ![]()
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