Source: Bloomberg

Author: Liz McCormick, Jonnelle Marte

According to some economists and participants in the bond market, the fierce debate of the US politics on improving the upper limit of debt may promote the Federal Reserve to end the quantitative tightening (QT) policy in advance.

By shrinking a monthly scale to up to 95 billion US dollars, the Fed is gradually returning to the liquidity of the financial system as a supplement to the tightening measure of interest rate hikes.If QT is ended in advance, some breathing opportunities can be brought to the US economy.

Through a series of complex chain reactions, the debt limit may eventually amplify the impact of QT later this year.

Commercial bank reserves stored in the Federal Reserve are part of the US financial foundation. When the Fed launched the first time that the QT caused the balance sheet in 2018 and 2019, the US stock market fell and the currency market was under pressure.The dynamics caused by the upper limit of debt may lead to accelerating the scales later this year. Even if the United States eventually avoid debt defaults, QT may end in advance.

RBC Capital Markets Blake Gwinn, the head of interest rate strategy, said, "This is a complicated factor because we don't know how the power of each share will be offset. In this process, there are actually two major sources of uncertainty.We don't know what the reasonable level of the reserve should be, and it is not clear how long it takes to reach that level. The debt limit has increased uncertainty to the pace of our goal. "

The situation has changed a lot compared to a few weeks ago.According to the December policy meeting, the Federal Reserve concluded a few weeks ago the conclusion of shrinking the table is "progressing smoothly."

The return of liquidity is mainly performed through two channels, namely bank reserves and so -called reverse repurchase protocol tools.Whether the former or the latter play a different impact, because economists believe that bank reserves can play a stronger role in supporting credit activities.

When the US Treasury Department uses cash reserves this year and starts to restrict the issuance of government bonds, the number of treasury coupons purchased by currency market funds will decrease.This means that they may store more funds through reverse repurchase agreements.

Then what may happen is that the bank's reserve will eventually accelerate.

John Velis, a foreign exchange and macro strategist in Meilong, New York, said, "All these cash will be used for reverse repurchase, which will lead to a decline in reserves."

He warned, "If the reserve is low to the dangerous level, there may be some situations in the market."

Fed Chairman Powell has not yet provided the latest information of any QT timetable.He said in July last year that the Federal Reserve model showed that after the Fed's easing policy during the epidemic, the bank reserve reserve will take two to two and a half years to reach a new equilibrium level.

John Williams, the president of the New York Federal Reserve Bank, said last week that decision makers are studying the risk of debt limit and potential fluctuations in the balance of reserves.

He told reporters, "Obviously, we are studying, and we must ensure that you have thought about it before making a decision."However, he does not think that the end time of QT will be earlier than expected, and he pointed out that excess funds participating in reverse repurchase may still be digested."This process takes time, obviously we will observe carefully."

Subadra Rajappa, director of interest rate strategy in France, said, "If funds do not start to flow out of reverse repurchase tools as Federal Reserve's expectations, bank reserves may decrease."

Warning signal

The Dallas Federal Reserve, Lorie Logan, who had been responsible for the management of bank asset liabilities in New York, said last week that if the reserve was too low, the Fed's new standing repurchase arrangement can be used as a reserve measure.

This is an unpredictable financing tool, which has a limit limit. If it is used, it may be an early warning signal with insufficient reserve.

Bank's reserve balance in the Federal Reserve has decreased by about 900 billion US dollars to about 3.1 trillion US dollars.It may rise in the short term.Once this process is completed, it is expected that it will decline.

Some Federal Reserve Observer expects that before the start of a new round of debt limit, the shrinkage may end at some time this year.

Solution

Ironically, what may have caused a greater impact on bank reserve is the final end of the debt limit deadlock.Once the Ministry of Finance obtains a freedom of debt, a series of treasury vouchers may be issued to raise funds. Its strong gold suction power may cause bank reserve custard to shrink sharply.

Observer said that the supply of short-term government bonds in the next few months may surge about 500 billion-800 billion US dollars

At the same time, Lh Meyer's economist Derek Tang predicts that if the bank starts to compete for deposits more intensely and withdraw cash from the currency fund and reverse repurchase tools, then the reserve may increase. QT will continue until 2024 until 2024Year.More Fed officials have mentioned this hypothetical situation over the past week.

Tang said, "the Fed seems to be more believed that the market will re -assign liquidity to the place in need."