Governor Waller suggests two significant changes to the Fed’s QT framework that effectively removes all obstacles to an extended QT. First, Waller suggests that the $2t in RRP balances should be consolidated with bank reserves when thinking of bank liquidity levels. This indicates that the Fed would be comfortable with bank reserve levels dropping below the roughly estimated $2.5t minimum level. Second, Waller appears to be open to maintaining QT even if policy rates are cut. This would reverse longstanding Fed dogma where both the policy rate and balance sheet must express the same stance of monetary policy. This post reviews these two developments and suggests that they represent an effort to re-tighten financial conditions by steepening the curve.
The Fed appears to have redefined their criteria for minimum banking sector liquidity in a way that enables QT to continue for years. QT withdraws liquidity out of the financial system, but in ways that the Fed is not able to control. The liquidity can come out of the banking sector (bank reserves), or it can come out of the RRP (RRP balances). So far, QT has largely drained liquidity out of the banking sector. This presents a problem to the Fed, who seeks to continue QT and also keep bank reserves levels above ~$2.5t. Reserve levels are around $3t today and on track to fall below the estimated minimal level by end 2023.