The Federal Reserve’s quantitative tightening (QT) program will conclude this December without causing significant market disruption, analysts at Barclays said in a recent note.
As they highlighted, this stands in stark contrast to the abrupt end of QT in 2019, which triggered a funding shock. The analysis from Barclays highlights the measures the Fed has implemented to avoid repeating past mistakes and ensure a smooth transition.
“The Fed continued QT for too long in 2019,” Barclays noted. “It did not have a good sense for banks' preferred levels of precautionary liquidity, and it focused too closely on developments in the fed funds market.”
This time, the Fed is taking a more cautious approach. The central bank has broadened its monitoring of funding conditions and started tapering QT with reserves still above $3.4 trillion. Moreover, central clearing and the Standing Repo Facility (SRF) provide additional safeguards against a funding shock similar to 2019.
Several indicators that signaled market strains in 2018-19 are now elevated. Hedge funds have similar levels of long Treasury positions financed with secured borrowing, and dealer balance sheets are congested with record-high Treasury holdings.
Now, Barclays believes that the Fed's preparedness and proactive measures will ensure a smooth end to QT.
“We think there are two factors pointing to a cleaner end to QT this year,” analysts wrote.
“First, the Fed seems to be paying more attention to markets and conditions outside the fed funds market,” the analysts state.
The second factor contributing to Barclays’ confidence is the expansion of sponsored repo activity and central clearing since 2020. These measures have significantly increased dealers' balance sheet capacity through netting.
“Sponsored repo – and central clearing more generally – expands dealers' balance sheet capacity through netting. Sponsored repo (longs and shorts) exceeds $1 trillion and has more than doubled since 2019,” the report highlights.
In sum, Barclays expects the Fed to end QT in December “with hardly a whimper” and “well before signs of stress emerge in either the fed funds or repo market.”