Morgan Stanley economists suggest that recent Fed communication has emphasized Quantitative Tightening (QT), anticipating discussions in upcoming meetings leading to a June start for tapering, earlier than initially expected.
However, the market's anticipation of the imminent end of QT is deemed exaggerated. The earlier taper initiation is expected to be coupled with a more gradual reduction.
“The Fed will start discussing tapering QT soon, but will not end QT soon,” analysts at Morgan Stanley said.
“We see the Fed discussing QT at upcoming meetings, likely announcing the parameters of a taper to QT in May and initiating the taper in June.”
Morgan Stanley's baseline projection anticipates the Fed halving the pace of QT for Treasuries to $30 billion per month, while Mortgage-Backed Securities (MBS) continue to run off with prepayments.
The SOMA portfolio is expected to decline by about $750 billion, the Reverse Repurchase (RRP) facility to reach approximately $0, and QT concluding in early 2025 when reserves hover around $3.2 trillion.
“Although markets will pay close attention to the Fed's balance sheet, we see the implications for fixed income markets as limited,” the analysts added.
“One key misconception is that QT necessarily means destruction in bank deposits. Indeed, over the past couple of quarters as the Fed's balance sheet has contracted, deposits have moved mostly sideways but have also actually edged up,” they concluded.