Federal Reserve's Potential End to Balance Sheet Run-Off: Strategic Asset Reallocation in Fixed Income and Equities

The Federal Reserve's quantitative tightening (QT) program, which has been reducing its balance sheet since 2022, is nearing a critical juncture. With Chair Jerome Powell signaling that the central bank may conclude its balance sheet runoff in the coming months, investors are recalibrating strategies to anticipate the implications for fixed income and equity markets. The end of QT, a cornerstone of post-pandemic monetary normalization, could reshape liquidity dynamics, yield curves, and risk premiums, creating both opportunities and risks for asset allocators.

Fixed Income: Yield Compression and Liquidity Rebalancing

The Fed's balance sheet runoff has historically acted as a drag on bond prices, as the sale of Treasuries and mortgage-backed securities (MBS) increased supply and pushed yields higher. However, the recent slowdown in QT-reducing Treasury runoff to $5 billion monthly from $25 billion-has already begun to alter this dynamic. According to a Federal Reserve note, money market funds (MMFs) have reallocated $2 trillion from the overnight reverse repurchase (ON RRP) facility into private repo and Treasury securities since 2023, driven by narrowing spreads between ON RRP and repo rates. This shift suggests that the market is primed for further liquidity absorption if QT concludes, potentially compressing Treasury yields as demand for safe assets intensifies.

The Fed's emphasis on maintaining "ample reserves" also underscores the role of interest on reserves (IORB) in stabilizing short-term rates. As Powell said in his October 2025 speech, the central bank will likely retain IORB as a key tool to manage liquidity, even after ending QT. This implies that bond yields may remain anchored to administered rates, limiting volatility but also capping upside potential for fixed income investors. For corporate bonds and high-yield markets, the end of QT could reduce pressure on credit spreads, as the Fed's reduced presence in the market eases supply-side constraints.

Equities: Liquidity-Driven Rotation and Sectoral Rebalancing

The end of QT is expected to inject liquidity into risk assets, favoring equities over cash. Historical precedent from the 2019 money market turbulence-when repo rates spiked due to excessive QT-has made the Fed cautious about abrupt liquidity shifts. Powell's recent remarks suggest a measured approach, with QT likely ending when reserves reach "somewhat above ample" levels, currently estimated near $3 trillion, according to Tomorrow Investor. This transition could lower equity risk premiums, as investors perceive a reduced likelihood of sudden liquidity crunches.

Sectoral reallocation is already underway. Technology and real estate, which thrive in low-rate environments, have outperformed since mid-2025, while financials and utilities-sensitive to interest rate changes-have lagged, Bloomberg reported. The Fed's pivot toward accommodative policy may amplify this trend, as lower yields reduce discount rates for growth stocks. However, the prolonged QT timeline introduces uncertainty. For instance, Deutsche Bank analysts note that a delayed end to QT (pushed to Q1 2026) could prolong volatility in sectors reliant on credit availability, such as commercial real estate, as reported by MNI Markets.

Strategic Reallocation Opportunities

Investors should prioritize three areas as the Fed's balance sheet normalization nears its conclusion:
1. Long-Duration Treasuries: With QT ending, demand for Treasuries is likely to outpace supply, creating a technical tailwind for yields to fall. This favors long-duration bonds, which benefit from price appreciation in a declining yield environment.
2. Growth Equities: Sectors like semiconductors and cloud infrastructure, which rely on low discount rates, stand to gain from a Fed pivot. The Nasdaq 100's outperformance since October 2025 reflects this shift.
3. Private Credit and Alternatives: As the Fed steps back from direct market interventions, private credit funds and infrastructure debt may fill the gap, offering higher yields than traditional fixed income.

Conclusion: Navigating the Post-QT Landscape

The Federal Reserve's potential end to balance sheet runoff marks a pivotal shift in monetary policy. While the exact timing remains data-dependent, the broader implications for asset allocation are clear: fixed income markets may see yield compression, and equities could benefit from a liquidity-driven risk-on environment. Investors must remain agile, balancing exposure to duration-sensitive assets with sectoral rotations that align with the Fed's evolving stance. As Powell emphasized, the central bank's cautious approach aims to avoid repeating past mistakes, but the transition to a post-QT world will require vigilance in navigating shifting liquidity dynamics.