Wall Street Awaits Fed Minutes For Possible Clues on the End of Quantitative Tightening

As discussions on Wall Street about when the Federal Reserve will end its current quantitative tightening (QT) policy continue to heat up, market strategists are hoping to gain more guidance from the Fed minutes to be released today.

Although most market observers currently predict that the Federal Reserve will completely end the balance sheet reduction at some point by the end of this year, the specific timing is far from certain. Therefore, the latest disclosure of the Federal Reserve's July meeting minutes is expected to attract much attention, and it may also provide more clues about the future direction of the Federal Reserve's interest rates.

The current interest in the topic of balance sheet reduction has been heightened to some extent because, over the past week, the New York Fed has released a series of research reports on the implementation of monetary policy and the balance of bank reserves, which are key to when the quantitative tightening policy can finally end.

Deutsche Bank's U.S. interest rate strategist, Steven Zeng, said that this may be exactly the signal that Federal Reserve policymakers are releasing as they approach the end of the quantitative tightening plan.

He said, "It's possible they published those notes to address the recent chatter about what's going on in repo - and QT needing to stop."

Since June 2022, the Federal Reserve has been reducing the size of its holdings, during which the Fed's balance sheet has shrunk by about $1.7 trillion, now down to about $7.2 trillion.

Starting in June this year, the Federal Reserve has decided to reduce the monthly U.S. Treasury deduction limit from $60 billion to $25 billion, part of which is to alleviate potential pressure on money market interest rates.

It is worth mentioning that in the past, the Federal Reserve has used the July window many times to announce important new tools related to the money market. For example, in July 2013, the committee discussed the implementation of the Federal Reserve's overnight reverse repurchase agreement mechanism (RRP), which is a barometer of whether there is an excess of liquidity in the financial system; in July 2021, they launched the Standing Repo Facility (SRF) for domestic and foreign enterprises.

This time, market participants will pay particular attention to any discussions and updates on bank reserve balances in the minutes. Federal Reserve policymakers have said that they still believe that the current level of reserves is ample, but there are concerns about whether this level can be maintained if the QT policy continues.

Liquidity Concerns Begin to Emerge

Earlier this month, the Federal Reserve's overnight reverse repurchase tool usage once fell below $300 billion, and the overnight repurchase rate has been high during the typical middle and end of the month, indicating that primary dealers are struggling to digest a large supply of Treasury bonds.

Dominion Securities' head of U.S. interest rate strategy, Gennadiy Goldberg, said, "There seems to be an increased focus on reserves. It shows that reserves are on the Fed's mind more than they have been in recent months, which suggests we may get some conversations around the appropriate level of reserves at a forthcoming FOMC meeting. It also suggests increased odds that QT's days are numbered."

Although there are still about $3.3 trillion in bank reserves deposited at the Federal Reserve, there are still many people in the market who are worried about the liquidity of the U.S. financial system, and how much the Fed's asset portfolio can be reduced before their are worrying cracks, similar to the situation that eventually occurred in the later stages of the balance sheet reduction five years ago.

Zeng said that Wall Street is also hoping that policymakers can clarify whether the development of Treasury issuance and the record position of dealers has affected their QT plan.