Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Head of Fixed Income Strategy
Irrespective of the macroeconomic landscape, QT tapering is inevitable for one reason: policymakers are wary of reaching the threshold of "ample reserves" in the coming months, fearing a liquidity squeeze akin to what occurred in 2019.
In the latest FOMC minutes the willingness of policy makers to taper QT as soon is possible is clear. “In light of the uncertainty regarding the level of reserves consistent with operating in an ample-reserves regime, slowing the pace of balance sheet runoff sooner rather than later would help facilitate a smooth transition from abundant to ample reserve balances”.
The notion of "ample reserves" remains somewhat abstract, as the exact threshold where reserves become scarce is uncertain. However, according to a St. Louis Fed paper, reserves at approximately 10% to 12% of nominal GDP—equating to between $2.7 trillion to $3.4 trillion based on 2023 year-end GDP levels—would be considered ample. With the Reverse Repurchase Facility recently dipping below $500 billion and projected to reach zero around summertime, the depletion of bank reserves at the Fed is imminent. Currently, bank reserves at the Fed stand at $3.4 trillion, aligning closely with the St. Louis Fed's conservative estimate of the ample/scarce reserve threshold.
If the Federal Reserve doesn’t initiate QT tapering by June, it risks intensifying the divestment of Fed T-Bills, exacerbating the strain already placed on the RRP facility.
We advocate for the implementation of QT tapering in June for the following reasons:
The latest FOMC minutes goes quite into detail regarding QT tapering and say that “participants generally favored reducing the monthly pace of runoff by roughly half from the recent overall pace.” That figure is not provided randomly.
By lowering QT cap from $60 billion to $30 billion, the Fed will be able to achieve the following from June ’24 to June ’25:
The yield curve is expected to continue disinverting and steepening. QT tapering is likely to benefit the front part of the yield curve, leading to a decrease in yields. The long part of the yield curve may experience some relief from the reduction in Quantitative Tightening (QT), but the US Treasury's need to maintain elevated coupon bond issuance might offset this.
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