The upcoming conclusion of the Federal Reserve’s quantitative tightening (QT) program in December is not expected to cause significant market disruption, according to analysts at Barclays. They noted that this differs from the sudden end of QT in 2019, which led to a funding shock. Barclays’ analysis emphasizes the Fed’s efforts to prevent a repeat of past mistakes and ensure a smooth transition.
“The Fed prolonged QT in 2019 without a clear understanding of banks’ preferred levels of precautionary liquidity, focusing too narrowly on developments in the fed funds market,” Barclays observed.
This time, the Fed is taking a more cautious approach by monitoring funding conditions more comprehensively and tapering QT while reserves are still above $3.4 trillion. Additionally, measures such as central clearing and the Standing Repo Facility (SRF) serve as safeguards against a funding shock similar to 2019.
Several indicators that previously signaled market strains are currently elevated, including high levels of long Treasury positions financed with secured borrowing by hedge funds and record-high Treasury holdings on dealer balance sheets.
Barclays is confident that the Fed’s preparedness and proactive measures will lead to a smooth conclusion of QT. “We believe two key factors point to a smoother end to QT this year,” the analysts stated.
“Firstly, the Fed is paying closer attention to markets and conditions beyond the fed funds market,” they added.
The expansion of sponsored repo activity and central clearing since 2020 is the second factor contributing to Barclays’ confidence. These initiatives have significantly increased dealers’ balance sheet capacity through netting.
“Sponsored repo and central clearing have expanded dealers’ balance sheet capacity through netting, with sponsored repo activity exceeding $1 trillion and more than doubling since 2019,” the report highlighted.
Overall, Barclays anticipates that the Fed will conclude QT in December “without much fanfare” and “well before any signs of stress emerge in the fed funds or repo market.”