Mapping the route out of QT and into an ample reserve regime
As the Fed continues its QT program of removing bank reserves from the system to return to what it deems as being an “ample reserve regime”, the Fed is now beginning to discuss what a post-QT world will look like, as well as what a QT taper may look like.
It is now well agreed upon that most Fed governors measure total system reserves as a combination of Fed bank reserves + Reverse Repo Facility Balances. The combination of the two provides us this chart of a total system reserve $ value of $4.07T.
As far as we know, the Fed targets approximately a floor of 10-12% of GDP as an ideal level for reserves within the system. Aside from that, the other best signals we have for knowing when we reach an equilibrium level of reserves is an uptick in SOFR-IORB spread, which would hint at a beginning shortage of collateral in the system:
As of right now, the spread is negative which means we are still in a regime of excess reserves. The fact there continues to be $450b in the RRP is further confirmation of this.
The other signal we can look at is uptake in the Fed’s Standing Repo Facility. The last time that the Fed attempted QT, there was no Standing Repo Facility available as a facility to absorb collateral demand which is what led to the end of the last QT campaign. With the SRF setup however, there will be no need for the Fed to enter that market overnight and provide liquidity since the SRF is already there for anyone that needs it. As we can see, there has been very little uptake in the SRF since 2020, hinting at little shortage for collateral within the system:
This discussion has so far been around the $ value of the Fed’s balance sheet. Let’s now shift gears towards the composition of that balance sheet and where the Fed is hoping to move it to.
As we can see in the chart below, the Fed’s SOMA holdings have the longest duration in history, primarily due to the amount of QE that has occurred in the last decade. Previous to the QE era we live in now, the Fed’s balance sheet was primarily composed of bills which closely matched the duration of the interest rates it aimed to target such as Federal Funds Rate.
Indeed, whereas before QE the WAM was around 3 years, it is currently at 8.60 years. The following chart provides a snapshot of how we’ve gotten here:
In a recent speech from Governor Waller analyzing a paper that was recently released on the differences between QE and QT in terms of their reaction on markets, he outlined a few things:
- He believes that since QT has a set $ value associated with it, the market prices in the operation swiftly and is therefore not a consideration to ongoing monetary policy.
- QE and QT are asymmetric in nature. 100b of QE does more for market upside than 100b of QT does for market downside.
- Waller is not worried about a repeat of September 2019 because of the standing repo facility being available, as discussed above.
- QT end will occur aside from broad monetary policy and interest rate targeting. He sees a regime where rates can come lower whilst QT continues.
- Waller wants to see MBS holdings go to 0 and not occur anymore. He wants the SOMA portfolio to be US debt only.
Finally, the most important insight from the speech is his inclination for wanting to shift the WAM of the SOMA portfolio from its current 8.60 years to being back to its 2008 level:
- “We held approximately one-third of our portfolio in Treasury bills. Today, bills are less than 5 percent of our Treasury holdings and less than 3 percent of our total securities holdings. Moving toward more Treasury bills would shift the maturity structure more toward our policy rate—the overnight federal funds rate—and allow our income and expenses to rise and fall together as the FOMC increases and cuts the target range. This approach could also assist a future asset purchase program because we could let the short-term securities roll off the portfolio and not increase the balance sheet”
Essentially, for the duration of SOMA to come down, either the Fed would need to substantially increase its bill buying (a version of QE but on the shorter end of the curve), or extend QT in a way where as those longer duration bonds mature, they would not roll the cash into the same duration.
Goodbye BTFP, hello Discount Window 2.0
The Bank Term Funding Program is being retired as of March 11. The BTFP has served as a temporary backstop facility for banks where they can post collateral that is severely discounted and it would get valued at par, allowing for banks that see significant outflows that impact their hold-to-maturity fixed income books from being force-sold before maturity at a discount to par. The banks could then receive a 1 year loan from the Fed directly to supplant liquidity needs associated with ongoing bank withdrawals.
With the combination of long end rates having come down and the flight from commercial banks into money market funds having slowed down, the need for commercial banks to have to sell HTM (hold to maturity) assets to fund withdrawals has slowed to the point where the stress has decreased significantly.
As seen in the chart below, one of the main reasons for the creation of the BTFP was because many smaller regional banks were not effectively set up to tap the discount window in a timely manner to fund liquidity restraints from bank withdrawals. If they were able to gain cash to ride out the wave until their HTM books of credit-risk-free Treasuries matured, there would have been no bank crisis.
It is for this reason that the FDIC, the Fed, and the Office of the Comptroller of the Currency have come together to revamp the Discount Window infrastructure rails to ensure that there is no further need for a facility like the BTFP in the future.
As long as the credit quality of the collateral, which for most banks was US Treasuries and therefore had the highest credit quality in the world, the banks could easily tap the Discount Window to ride out the wave of withdrawals whilst waiting for their HTM bond books to mature at par.
New guidelines are being announced to have banks tap the Discount Window on an annual basis as a form of stress test and to remove further stigma from using the Discount Window. With this plan in play, the Fed now feels comfortable to unwind the BTFP facility and move to further expanding its Discount Window rails instead. Furthermore, banks, if they truly needed a facility where their collateral would be valued at par instead of their current discounts to par, would still be able to take on a BTFP loan in the lead up to March 11th that would last another year and into March 2025. Considering that we have seen no uptake and that the uptake in the fall/early 2024 was due to an arbitrage opportunity between IORB and BTFP rates for banks, there is clearly no evidence of demand for the facility at this time.
In conclusion, I believe that the unwind of the BTFP facility is a non-event, especially in a regime where rates have peaked on a cyclical level and the discount to par of those HTM bond books will continue to tighten as rates come down.
That concludes our adventure into getting a pulse of where things stand in the complex world of monetary plumbing. Overall, the takeaways are:
- The Fed is planning what a post-QT world is going to look like and wants to return to a regime of more traditional tools being used such as the Discount Window
- The Fed does not view QT as an active monetary policy tool and wants interest rate targeting to be its key bellwether of where they stand in terms of monetary policy
- The Fed is not concerned with a bank crisis 2.0 and is overall laying the groundwork for moving from its recent rate hiking cycle into a more dovish and easing-based cycle from here.
Disclaimer: This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.
Mapping the route out of QT and into an ample reserve regime
As the Fed continues its QT program of removing bank reserves from the system to return to what it deems as being an “ample reserve regime”, the Fed is now beginning to discuss what a post-QT world will look like, as well as what a QT taper may look like.
It is now well agreed upon that most Fed governors measure total system reserves as a combination of Fed bank reserves + Reverse Repo Facility Balances. The combination of the two provides us this chart of a total system reserve $ value of $4.07T.
As far as we know, the Fed targets approximately a floor of 10-12% of GDP as an ideal level for reserves within the system. Aside from that, the other best signals we have for knowing when we reach an equilibrium level of reserves is an uptick in SOFR-IORB spread, which would hint at a beginning shortage of collateral in the system:
As of right now, the spread is negative which means we are still in a regime of excess reserves. The fact there continues to be $450b in the RRP is further confirmation of this.
The other signal we can look at is uptake in the Fed’s Standing Repo Facility. The last time that the Fed attempted QT, there was no Standing Repo Facility available as a facility to absorb collateral demand which is what led to the end of the last QT campaign. With the SRF setup however, there will be no need for the Fed to enter that market overnight and provide liquidity since the SRF is already there for anyone that needs it. As we can see, there has been very little uptake in the SRF since 2020, hinting at little shortage for collateral within the system:
This discussion has so far been around the $ value of the Fed’s balance sheet. Let’s now shift gears towards the composition of that balance sheet and where the Fed is hoping to move it to.
As we can see in the chart below, the Fed’s SOMA holdings have the longest duration in history, primarily due to the amount of QE that has occurred in the last decade. Previous to the QE era we live in now, the Fed’s balance sheet was primarily composed of bills which closely matched the duration of the interest rates it aimed to target such as Federal Funds Rate.
Indeed, whereas before QE the WAM was around 3 years, it is currently at 8.60 years. The following chart provides a snapshot of how we’ve gotten here:
In a recent speech from Governor Waller analyzing a paper that was recently released on the differences between QE and QT in terms of their reaction on markets, he outlined a few things:
- He believes that since QT has a set $ value associated with it, the market prices in the operation swiftly and is therefore not a consideration to ongoing monetary policy.
- QE and QT are asymmetric in nature. 100b of QE does more for market upside than 100b of QT does for market downside.
- Waller is not worried about a repeat of September 2019 because of the standing repo facility being available, as discussed above.
- QT end will occur aside from broad monetary policy and interest rate targeting. He sees a regime where rates can come lower whilst QT continues.
- Waller wants to see MBS holdings go to 0 and not occur anymore. He wants the SOMA portfolio to be US debt only.
Finally, the most important insight from the speech is his inclination for wanting to shift the WAM of the SOMA portfolio from its current 8.60 years to being back to its 2008 level:
- “We held approximately one-third of our portfolio in Treasury bills. Today, bills are less than 5 percent of our Treasury holdings and less than 3 percent of our total securities holdings. Moving toward more Treasury bills would shift the maturity structure more toward our policy rate—the overnight federal funds rate—and allow our income and expenses to rise and fall together as the FOMC increases and cuts the target range. This approach could also assist a future asset purchase program because we could let the short-term securities roll off the portfolio and not increase the balance sheet”
Essentially, for the duration of SOMA to come down, either the Fed would need to substantially increase its bill buying (a version of QE but on the shorter end of the curve), or extend QT in a way where as those longer duration bonds mature, they would not roll the cash into the same duration.
Goodbye BTFP, hello Discount Window 2.0
The Bank Term Funding Program is being retired as of March 11. The BTFP has served as a temporary backstop facility for banks where they can post collateral that is severely discounted and it would get valued at par, allowing for banks that see significant outflows that impact their hold-to-maturity fixed income books from being force-sold before maturity at a discount to par. The banks could then receive a 1 year loan from the Fed directly to supplant liquidity needs associated with ongoing bank withdrawals.
With the combination of long end rates having come down and the flight from commercial banks into money market funds having slowed down, the need for commercial banks to have to sell HTM (hold to maturity) assets to fund withdrawals has slowed to the point where the stress has decreased significantly.
As seen in the chart below, one of the main reasons for the creation of the BTFP was because many smaller regional banks were not effectively set up to tap the discount window in a timely manner to fund liquidity restraints from bank withdrawals. If they were able to gain cash to ride out the wave until their HTM books of credit-risk-free Treasuries matured, there would have been no bank crisis.
It is for this reason that the FDIC, the Fed, and the Office of the Comptroller of the Currency have come together to revamp the Discount Window infrastructure rails to ensure that there is no further need for a facility like the BTFP in the future.
As long as the credit quality of the collateral, which for most banks was US Treasuries and therefore had the highest credit quality in the world, the banks could easily tap the Discount Window to ride out the wave of withdrawals whilst waiting for their HTM bond books to mature at par.
New guidelines are being announced to have banks tap the Discount Window on an annual basis as a form of stress test and to remove further stigma from using the Discount Window. With this plan in play, the Fed now feels comfortable to unwind the BTFP facility and move to further expanding its Discount Window rails instead. Furthermore, banks, if they truly needed a facility where their collateral would be valued at par instead of their current discounts to par, would still be able to take on a BTFP loan in the lead up to March 11th that would last another year and into March 2025. Considering that we have seen no uptake and that the uptake in the fall/early 2024 was due to an arbitrage opportunity between IORB and BTFP rates for banks, there is clearly no evidence of demand for the facility at this time.
In conclusion, I believe that the unwind of the BTFP facility is a non-event, especially in a regime where rates have peaked on a cyclical level and the discount to par of those HTM bond books will continue to tighten as rates come down.
That concludes our adventure into getting a pulse of where things stand in the complex world of monetary plumbing. Overall, the takeaways are:
- The Fed is planning what a post-QT world is going to look like and wants to return to a regime of more traditional tools being used such as the Discount Window
- The Fed does not view QT as an active monetary policy tool and wants interest rate targeting to be its key bellwether of where they stand in terms of monetary policy
- The Fed is not concerned with a bank crisis 2.0 and is overall laying the groundwork for moving from its recent rate hiking cycle into a more dovish and easing-based cycle from here.
Disclaimer: This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.
Mapping the route out of QT and into an ample reserve regime
As the Fed continues its QT program of removing bank reserves from the system to return to what it deems as being an “ample reserve regime”, the Fed is now beginning to discuss what a post-QT world will look like, as well as what a QT taper may look like.
It is now well agreed upon that most Fed governors measure total system reserves as a combination of Fed bank reserves + Reverse Repo Facility Balances. The combination of the two provides us this chart of a total system reserve $ value of $4.07T.
As far as we know, the Fed targets approximately a floor of 10-12% of GDP as an ideal level for reserves within the system. Aside from that, the other best signals we have for knowing when we reach an equilibrium level of reserves is an uptick in SOFR-IORB spread, which would hint at a beginning shortage of collateral in the system:
As of right now, the spread is negative which means we are still in a regime of excess reserves. The fact there continues to be $450b in the RRP is further confirmation of this.
The other signal we can look at is uptake in the Fed’s Standing Repo Facility. The last time that the Fed attempted QT, there was no Standing Repo Facility available as a facility to absorb collateral demand which is what led to the end of the last QT campaign. With the SRF setup however, there will be no need for the Fed to enter that market overnight and provide liquidity since the SRF is already there for anyone that needs it. As we can see, there has been very little uptake in the SRF since 2020, hinting at little shortage for collateral within the system:
This discussion has so far been around the $ value of the Fed’s balance sheet. Let’s now shift gears towards the composition of that balance sheet and where the Fed is hoping to move it to.
As we can see in the chart below, the Fed’s SOMA holdings have the longest duration in history, primarily due to the amount of QE that has occurred in the last decade. Previous to the QE era we live in now, the Fed’s balance sheet was primarily composed of bills which closely matched the duration of the interest rates it aimed to target such as Federal Funds Rate.
Indeed, whereas before QE the WAM was around 3 years, it is currently at 8.60 years. The following chart provides a snapshot of how we’ve gotten here:
In a recent speech from Governor Waller analyzing a paper that was recently released on the differences between QE and QT in terms of their reaction on markets, he outlined a few things:
- He believes that since QT has a set $ value associated with it, the market prices in the operation swiftly and is therefore not a consideration to ongoing monetary policy.
- QE and QT are asymmetric in nature. 100b of QE does more for market upside than 100b of QT does for market downside.
- Waller is not worried about a repeat of September 2019 because of the standing repo facility being available, as discussed above.
- QT end will occur aside from broad monetary policy and interest rate targeting. He sees a regime where rates can come lower whilst QT continues.
- Waller wants to see MBS holdings go to 0 and not occur anymore. He wants the SOMA portfolio to be US debt only.
Finally, the most important insight from the speech is his inclination for wanting to shift the WAM of the SOMA portfolio from its current 8.60 years to being back to its 2008 level:
- “We held approximately one-third of our portfolio in Treasury bills. Today, bills are less than 5 percent of our Treasury holdings and less than 3 percent of our total securities holdings. Moving toward more Treasury bills would shift the maturity structure more toward our policy rate—the overnight federal funds rate—and allow our income and expenses to rise and fall together as the FOMC increases and cuts the target range. This approach could also assist a future asset purchase program because we could let the short-term securities roll off the portfolio and not increase the balance sheet”
Essentially, for the duration of SOMA to come down, either the Fed would need to substantially increase its bill buying (a version of QE but on the shorter end of the curve), or extend QT in a way where as those longer duration bonds mature, they would not roll the cash into the same duration.
Goodbye BTFP, hello Discount Window 2.0
The Bank Term Funding Program is being retired as of March 11. The BTFP has served as a temporary backstop facility for banks where they can post collateral that is severely discounted and it would get valued at par, allowing for banks that see significant outflows that impact their hold-to-maturity fixed income books from being force-sold before maturity at a discount to par. The banks could then receive a 1 year loan from the Fed directly to supplant liquidity needs associated with ongoing bank withdrawals.
With the combination of long end rates having come down and the flight from commercial banks into money market funds having slowed down, the need for commercial banks to have to sell HTM (hold to maturity) assets to fund withdrawals has slowed to the point where the stress has decreased significantly.
As seen in the chart below, one of the main reasons for the creation of the BTFP was because many smaller regional banks were not effectively set up to tap the discount window in a timely manner to fund liquidity restraints from bank withdrawals. If they were able to gain cash to ride out the wave until their HTM books of credit-risk-free Treasuries matured, there would have been no bank crisis.
It is for this reason that the FDIC, the Fed, and the Office of the Comptroller of the Currency have come together to revamp the Discount Window infrastructure rails to ensure that there is no further need for a facility like the BTFP in the future.
As long as the credit quality of the collateral, which for most banks was US Treasuries and therefore had the highest credit quality in the world, the banks could easily tap the Discount Window to ride out the wave of withdrawals whilst waiting for their HTM bond books to mature at par.
New guidelines are being announced to have banks tap the Discount Window on an annual basis as a form of stress test and to remove further stigma from using the Discount Window. With this plan in play, the Fed now feels comfortable to unwind the BTFP facility and move to further expanding its Discount Window rails instead. Furthermore, banks, if they truly needed a facility where their collateral would be valued at par instead of their current discounts to par, would still be able to take on a BTFP loan in the lead up to March 11th that would last another year and into March 2025. Considering that we have seen no uptake and that the uptake in the fall/early 2024 was due to an arbitrage opportunity between IORB and BTFP rates for banks, there is clearly no evidence of demand for the facility at this time.
In conclusion, I believe that the unwind of the BTFP facility is a non-event, especially in a regime where rates have peaked on a cyclical level and the discount to par of those HTM bond books will continue to tighten as rates come down.
That concludes our adventure into getting a pulse of where things stand in the complex world of monetary plumbing. Overall, the takeaways are:
- The Fed is planning what a post-QT world is going to look like and wants to return to a regime of more traditional tools being used such as the Discount Window
- The Fed does not view QT as an active monetary policy tool and wants interest rate targeting to be its key bellwether of where they stand in terms of monetary policy
- The Fed is not concerned with a bank crisis 2.0 and is overall laying the groundwork for moving from its recent rate hiking cycle into a more dovish and easing-based cycle from here.
Disclaimer: This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.
