QT-Lite: Quantitative Tightening's Limited Impact

Quick read:

  • The Federal Reserve’s balance sheet is one of the world’s most important security portfolios. Yet, its ongoing importance for markets and financial conditions is often underappreciated.
  • Over the last 15 years, both the size and duration profile of the Fed’s balance sheet have expanded meaningfully. As a share of GDP, the Fed’s securities portfolio is 7x as large in notional terms and 9x as large in terms of duration equivalents compared to the beginning of 2009.
  • The composition of the asset side of the Fed’s balance sheet offsets some of the intended tightening effects of higher policy rates. Research by the Federal Reserve and our own analysis suggest that current Fed holdings of long-dated Treasuries and mortgages exert a powerful downward force on bond yields – equivalent to a policy rate easing of about 2%.
  • Going forward, we think there is an underappreciated likelihood that the Fed could be more active with regards to shifting the composition of its balance sheet towards shorter duration securities if further policy tightening is needed. This transition would pose downside risks for long-dated US government bond prices and the US dollar.