GM. This is Milk Road Macro, the newsletter that breaks down Fed speak like it’s ancient scrolls decoded by Indiana Jones.
Here’s what we got for you today:
- ✍️ Everything you need to know about QT, QE, and what happens next
- 🎙️ The Milk Road Macro Show: Ignore the Headlines. The Charts Are Screaming Bull Market w/ Caleb Franzen
- 🍪 AI boom strains phone and PC chips
Prices as of 8:00 AM ET.
EVERYTHING YOU NEED TO KNOW ABOUT QT, QE, AND WHAT HAPPENS NEXT
The Federal Reserve will stop its Quantitative Tightening (QT) regime soon.
That’s what Fed Chair Jerome Powell signaled last week.
This is a big monetary policy pivot for the Fed.
Some people are already speculating about what might happen next - a return to Quantitative Easing (QE)?
Will we see another burst of 2020-like “turbo QE”?
(The answer is very likely to be no.)
So, what’s going on?
Why is the Fed stopping QT?
What does it mean for asset markets?
And what happens next?
Let’s take a look…
So, what’s going on?
Between 2019 and 2022, the Federal Reserve rapidly expanded its balance sheet (also known as QE) - by more than $5 trillion.
This means it bought bonds, mostly Government bonds, from the market - this is effectively an injection of cash into the financial system.
It coincided with the “everything bubble” we saw within asset markets through 2020 and 2021.
Then in 2022, the Fed began the process of reducing its balance sheet (also known as QT).
This means allowing bonds to mature without reinvesting the proceeds, and in some cases selling bonds back to the market - this is the reverse of QE and is effectively a cash drain.
The pace of the balance sheet reduction has been “tapered” since it began - so it’s now only running at a very slow pace.
In a speech last week, Powell said the Fed “may approach that point in the coming months” where it would “stop balance sheet run-off”.
If we untangle this central banker speak - this actually means: “we are stopping QT soon”.
He wouldn’t have said it otherwise.
This is clear “forward guidance” for markets.
The Fed always gently eases policy changes into place.
Why is the Fed stopping QT?
A QT halt is not that much of a surprise to markets - it’s been widely expected by market participants in the Fed’s own surveys.
In fact, I’ve written about this twice - here and here - anticipating a stop to QT around the end of 2025.
It’s all about bank reserves.
Bank reserves are very important for the financial system - they basically underpin the ecosystem.
QT puts gradual downward pressure on bank reserves.
Recently, bank reserves have been reaching levels that many experts have labelled as potentially signaling “scarce reserves” (between 7% and 10% - as a percentage of GDP).
This contraction in bank reserves can cause issues deep within the plumbing of the financial system.
These “issues” appear in important dollar funding markets like SOFR (Secured Overnight Financing Rate).
If things are running “smoothly”, the spread between SOFR and IORB (Interest on Reserve Balances) should remain below 0.
But recently, this spread has been spiking above 0 and remaining there, which indicates minor funding stress and could mean bank reserves may be starting to become “scarce”.
This funding stress is probably not that concerning currently - it’s still relatively minor.
But the Fed won’t want to relive what happened in September 2019 - the “Repo Crisis” - when reserves dipped too low, funding rates surged and there was utter chaos in the banking system.
Last week, Powell said: “Some signs have begun to emerge that liquidity conditions generally are tightening”.
A stop to QT would alleviate downward pressure on bank reserves.
What does it mean for asset markets?
Because QT has already been “tapered” to a slow pace - the actual material liquidity impact of stopping it altogether would be very small.
Also, a QT halt has been widely anticipated, so it’s not a big surprise.
It may prove to be a small “bullish signal” for risk asset markets - but that’s about it.
Some people will speculate about what happens next - if/when the Fed will begin to increase its balance sheet again.
Let’s take a sensible look at what’s most likely to happen next.
What happens next?
An end to QT does not mean an immediate restart of big QE.
It’s extremely unlikely we will see anything like the “turbo QE” we’ve seen in the past unless we see a crisis of some kind (major recession, war, pandemic, serious banking crisis).
Judging by previous Fed communication, the most likely scenario - at some point after QT ends - is a very slow increase of the balance sheet.
A Fed paper from 2024 shows a projection of the balance sheet growing at a snail’s pace, in tandem with GDP growth.
Source: Federal Reserve Bank of New York
If this plan comes to fruition, I’m sure it won’t be labelled as “QE” - more likely something along the lines of “reserve management”.
But, as Mike Tyson says - “everybody has a plan until they get punched in the mouth”.
The Fed has a plan to grow the balance sheet slowly.
But the Fed could possibly still get “punched in the mouth”, if dollar funding stress worsens and it needs to step in to provide more liquidity quickly.
However - now, I’m going to get really nerdy (and this might be a little too nerdy for some).
Despite the fact that the balance sheet may start to increase again at some point - it’s possible this could be done in a way that isn’t particularly “liquidity positive” overall.
This is because there has been chatter among some Fed Governors around the composition of the balance sheet.
Some Fed members have indicated they may want to shift the overall balance sheet composition away from longer-dated Treasuries and towards shorter-dated Treasuries.
So, the Fed could increase the balance sheet while also increasing the supply of longer-dated Treasuries in the market.
This would not be a particularly “liquidity positive” scenario overall and would not have the same “QE-like” market effects that we’ve seen in the past (i.e. help to push asset prices up).
Wrapping up
It looks like the Fed’s QT regime will come to an end in the coming months.
Some minor stress is showing up in important funding markets.
But this doesn’t mean a return to 2020-like QE.
The current plan is to grow the balance sheet very slowly.
But, even if the Fed does start to increase its balance sheet again - it’s possible it could do so in a way that is very different to how it has in the past.
So, it’s also important to monitor how the Fed might grow its balance sheet.
I’ll be breaking down all the details in this newsletter as things progress.
But for now, I’ll leave it here - catch you for the next edition.
BULL MARKET STILL ON? LET’S GO 🚀
In today’s episode, we sat down with Caleb Franzen to talk about why he believes the bull market is still alive and well, even with all the recent noise.
Here’s what you’ll hear:
- Why recent volatility is just a correction, not a trend reversal
- How small-cap growth vs value tells the real macro story
- Why Caleb is still 80% in Bitcoin, even after a $20B liquidation
- The liquidity signals flashing green (and what they mean for your portfolio)
It’s a banger of an episode, don’t miss it 👇
YouTube | Spotify | Apple Podcasts
BITE-SIZED COOKIES FOR THE ROAD 🍪
Donald Trump has signed a rare earths deal with Australia. As China weaponizes rare earths against the US in trade talks, Trump has penned a deal with Australia to help supply the US with critical minerals.
The global rush to produce AI chips is tightening the supply of less glamorous chips used in smartphones and computers. Some customers are panic-buying more mundane and run-of-the-mill semiconductors, which has seen their prices surge.
Sanae Takaichi is set to become Japan's first female prime minister after a coalition agreement was signed on Monday. Takaichi is expected to unleash big fiscal spending and pressure the Bank of Japan to keep interest rates low.
The Milk Road portfolio just got a glow up. Our revamped All Access portfolio page now includes interactive charts, performance benchmarks, and real-time allocation data so you can see exactly how we're positioning across every market cycle. It’s the same portfolio, just sharper, cleaner, and way more fun to poke around.
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