Debt-Limit Fight Risks Early End to Fed Quantitative Tightening

The Federal Reserve’s quantitative-tightening program risks being propelled toward an early end as US politicians bicker in Washington over raising the national debt limit, according to some economists and bond-market participants.

By shrinking its bond portfolio by up to $95 billion a month, the central bank is draining liquidity from the US financial system — complementing its interest-rate hikes in the battle to control inflation. An early end to QT could therefore provide the US economy with some relief.

Through a complex series of reactions, constraints imposed on the Treasury Department by the debt limit could end up amplifying some of the impact of QT later this year.

Commercial bank reserves parked at the Fed form a part of the US financial bedrock, and when the Fed’s first foray with QT caused them to shrink in 2018 and 2019, stocks saw declines and money markets seized up. Dynamics caused by the debt limit could have the effect of a more rapid shrinking of reserves later this year — potentially bringing forward the end of QT, even if the US avoids a default.

“It’s a complicating factor — because we just don’t know how all these things are going to net out against each other,” said Blake Gwinn, head of US rates strategy at RBC Capital Markets. “There’s really two major sources of uncertainty around this process. We don’t know what the right level of reserves is,” nor how long it will take to get there, he said. And the debt limit “adds uncertainty around the pace at which we’re getting to that end level.”