MNI INTERVIEW: Fed Soon To End QT On Funding Strains - Wright

Renewed money market strains will prompt the Federal Reserve to end quantitative tightening soon and resume asset purchases within six to 12 months after that, former Fed Board economist Jonathan Wright told MNI. 

Key short-term borrowing rates spiked about 10 basis points last Wednesday, the same day as a large Treasury coupon settlement, and stayed elevated Thursday as banks tapped the Fed’s standing repo facility, a backstop that provides cash in exchange for U.S. Treasuries and agency bonds. 

"It looks to me like we’re at about the same place as early 2019, where there are signs of trouble on the horizon but nothing you can call turmoil in money markets yet. But continuing to reduce the amount of bank reserves will at some point get us to a steep part of the demand curve – at least on some days – and run a risk of a repeat of what happened in September 2019," Wright, an economist at Johns Hopkins University, said in an interview. 

"The Fed is probably going to want to stop QT pretty soon, and not long after that actually resume expansion of the balance sheet to give them a little more cushion to operate in the framework of ample reserves.”

Liquidity conditions have tightened in the past few months not because of QT, according to Wright, but due to swings in the Treasury General Account, which is essentially the checking account for the federal government. Since the Fed launched QT in June 2022, the monthly cap on roll-offs had already been lowered twice to USD5 billion per month for Treasuries and USD35 billion per month for agency mortgage debt. 

The TGA stands at about USD800 billion and could rise to USD1 trillion, which would mechanically lower reserves nearly dollar-for-dollar, Wright said. That would shave reserves, currently at about USD3.0 trillion, down to levels close to Fed Governor Chris Waller's estimate of "roughly ample reserves" at USD2.7 trillion or 9% of GDP. 

"QT has almost stopped, so just switching to ending QT doesn’t really change the pace of decline of the Fed’s balance sheet much," he said. "Six months to a year I'd give it before they resume purchases." (See: MNI POLICY: Fed Seeks Market Signals To End QT, Pause Possible)

GETTING SMALLER

The desire to run a smaller balance sheet appears to be growing even among Fed officials who feel comfortable with a permanently large pool of reserves in the banking system, Wright said. The Fed has been under renewed political pressure to do so after it reported losses of USD78 billion in 2024 and USD114 billion in 2023 on rising interest expenses.

"I do think the tide has turned somewhat in favor of a smaller balance sheet," Wright said. "The view used to be out there that there was really no cost to having a big balance sheet. Now there’s a lot more debate about that. The cost is killing the interbank market, and having a big balance sheet puts the Fed under pressure to do thing with that balance sheet capacity and fund fiscal projects." 

While it will never return to a pre-financial crisis balance sheet size, the Fed could over the long run encourage banks to hold less reserves and further destigmatize the usage of the standing repo facility and discount window, Wright said. 

"That would not reduce reserve demand to where it was in 2007, but conceivably it would reduce it a fair bit and allow the balance sheet to shrink a bit more," he said. 

The central bank's tolerance for rate volatility day-to-day likely also needs to rise, he added. 

"If they were willing to tolerate more volatility on special days like quarter-end or tax payment days, they could get away with a little more scarcity in reserves." (See: MNI: Fed's Standing Repo Facility Tested By Market Rate Spike)