The Fed looks set to end its massive market intervention. Can it do that without spooking traders?

By Greg Robb

Dallas Fed President Lorie Logan likens the process to a ferry slowing down so it can more easily gauge when to stop at the dock

The Federal Reserve is poised to end its latest program of quantitative tightening, bringing the curtain down on the massive intervention in financial markets it launched in March 2020 at the start of the COVID-19 crisis.

The Fed hopes that the markets can stand on their own and that the central bank can return to stimulating and cooling the economy using its traditional interest-rate tool.

To counter the economic impact of the pandemic, the Fed embarked on a program of quantitative easing, buying up trillions of dollars' worth of securities to keep long-term interest rates low. As a result, the central bank's balance sheet swelled to close to $9 trillion.

Since 2022, the Fed has been reversing that stimulus through quantitative tightening, letting its balance sheet shrink by $2.2 trillion.

The Fed wanted to move bank reserves from "abundant" to "ample" but didn't know when exactly it should end QT. Bank reserves as a share of nominal gross domestic product are roughly 10% today.

At the same time, the Fed is trying to avoid the mistake it made in the first QE episode, in the wake of the 2007-09 recession, when it allowed bank reserves to trend down to 6.5%. Markets seized on the lack of liquidity, causing a sharp 300-basis-point jump in overnight interest rates, and the Fed had to quickly reverse course and buy assets.

To avoid another market meltdown, the Fed has been slowly shrinking the balance sheet, cutting the pace to roll off $5 billion worth of Treasurys per month.

Dallas Fed President Lorie Logan compared the process to a ferry slowing down so it could more easily gauge when to stop at the dock.

Earlier this month, Fed Chair Jerome Powell gave a speech focusing on the balance sheet, sending a signal that a change in policy is coming, said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities.

Experts in the plumbing of the U.S. financial system say they see signs - namely money-market interest rates moving higher - that the Fed should end QT.

"The proximity alarms are starting to go off. We've seen enough change in market conditions that there is no point in waiting" to end the QT program, said Lou Crandall, chief economist at Wrightson ICAP, in an interview.

Markets may read end of QT as a sign the Fed wants to boost the economy

Some traders will interpret the ending of QT as another policy measure intended to inflate the economy, said Thierry Wizman, global rates strategist at Macquarie Group.

And some experts think conditions in the money markets indicate that the Fed is in danger of repeating its 2019 mistake of taking too much liquidity out of the system. They are urging the Fed to restart buying securities.

Marc Cabana, head of U.S. rates strategy at Bank of America Securities, thinks the Fed has let too many reserves roll off its balance sheet - essentially overshooting the dock. He thinks the central bank will have to buy more bills to add more liquidity back into the market.

Some market participants will believe any addition of liquidity is a sign financial conditions are easing, although the Fed insists this type of balance-sheet growth is different. In QE, the Fed is buying longer-term assets to lower the price. Balance-sheet management will focus on bills with little duration.

Still, "broader participants in the market will believe this is a sign of financial conditions easing - equities up," despite what experts say, Cabana said.

"The Fed will have to live with the consequences - and that may mean some misinterpretation," Cabana said.

Goldberg said he doesn't think the Fed sees a need to buy more securities - yet. He forecasts that the central bank won't add to the balance sheet until late 2026. But he thinks it will be watching the cost of funding at the end of the year and would move if there is market pressure.

At the same time as it ends QT, the Fed will keep allowing mortgage-backed securities to run off but will reinvest the proceeds into Treasury bills, Goldberg said.

The Fed holds $2.1 trillion in mortgage-backed securities but, over time, wants its portfolio to consist primarily of Treasurys.

A relatively new tool for the Fed

Purchasing securities in a crisis is still a relatively new tactic for the central bank.

After its two bond-buying programs, the Fed will be much more cautious about using QE as a tool for monetary-policy stimulus, Crandall said.

Critics of QE say it gives the Fed too great a footprint in financial markets.

Crandall said he doesn't think Fed officials will again face the conditions that led to QE in the foreseeable future. In both times of QE, the Fed didn't launch the program until it had moved its target interest-rate range close to zero, a flashing signal of falling consumer prices.

The economy in the coming years is more likely to see rising prices, Crandall said.

"I don't think we're going to be worried about deflation anytime soon," he said.

Ryan Boyle, chief U.S. economist at Northern Trust, said that Powell may view the balance sheet as the last piece of unfinished business before his term ends next May.

"Leaving the balance sheet in a steady state will make it more difficult for any successor to change its use until another crisis opens this path again," Boyle said.

-Greg Robb

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10-28-25 1637ET

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