31 October 2025

The important Fed decision yesterday was not the rate cut (or the guidance of future interest rates), but the termination of QT, effective Dec 1. Since the introduction of QT in 2022, the Fed has allowed Treasuries and MBS to mature without buying replacements, thus enabling the shrinkage of its balance sheet by $2tr. 

This Letter examines the huge policy implications of the Fed terminating Quantitative Tightening (QT), including the root causes of the liquidity shortage, its impact on the stock market, Federal debt, as well as the dollar.

The Fed used strains in the repo market as the rationale to terminate QT, as it also did in 2019. Banks used the Fed’s Standing Repo Facility (SRF) to borrow $15 bl in mid-Oct, because the repo rate exceeded the Fed benchmark rate of 4.25% making it cheaper to borrow from the Fed than the repo market. The SRF was introduced in 2021 as a permanent replacement for emergency repo operations.  

The Fed allows banks to borrow cash from the Fed during twice-daily operations in return for collateral, such as Treasuries. Therefore, in normal money market liquidity conditions, the SRF is rarely used because the Fed rates are higher than the repo rates. So, the use of SRF in mid-Oct highlights shortage of liquidity. The deep reason of financial stress is that QT depletes banks’ excess reserves. So, the Fed decision to terminate QT is not surprising, but has huge implications…