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The liquidity conundrum

The uncertainty regarding rates has gone away after Wednesday, when the Fed Chairman communicated his expectations for the rest of the year. But there is another important part of monetary policy, which is the Fed’s balance sheet. The Fed started the quantitative tightening program (balance sheet reduction) in June 2022, and it’s been allowing a $95Bn monthly runoff in its portfolio. But it’s highly likely they will reduce that pace going into the end of the year; at the same time, they have been reducing its Reverse Repo program, from $2Tn to $400Bn. The amount of liquidity drained from the system is huge. The Fed has been tightening with rates, with QT, with the reverse repo program and they stopped extending loans to banks through BTFP. And yet, the economy and the market seem to be functioning normally, because of the expectations they will ease on tightening through lower rates, and less QT. The execution in terms of timing and amount of both programs is expected to be flawless.

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Source: Jurrien Timmer

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