ATFX - the size of the Federal Reserve's balance sheet is expected to reach 100 million dollars this month! Market volatility may intensify

At a time when the US government is borrowing heavily，The Federal Reserve will continue to shrink its balance sheet，Will the market turmoil of 2019 return?

The Fed's balance sheet is expected to shrink by $1 trillion this month，This is an important milestone in the Fed's reversal of loose monetary policy during the epidemic.However，Investors are warned，Further balance sheet cuts could trigger financial marekt.

In the early days of the COVID-19 pandemic，The Federal Reserve has purchased trillions of dollars in government bonds and mortgage-backed securities，To stabilize the financial system，But the maturing bonds were no longer reinvested last spring. As of August 9，Since the balance sheet peaked at $8.55 trillion last May，The Fed's portfolio has shrunk by 980 billion dollars.Analysis shows that，Before the end of this month，The scale of the shrinkage is expected to exceed 1 trillion dollars.

The Federal Reserve is shrinking its balance sheet (i.e., quantitative tightening).，The government bond market has lost one of its largest buyers as a result，thusIncreases the supply of debt that private investors must absorb.

For the Federal Reserve，Quantitative tightening (QT) can be a difficult path. The last round of QT by the Federal Reserve caused borrowing costs to soar sharply，Trigger market volatility，Forced to end in 2019.

So far.，The latest round of austerity is well underway，But its speed is almost twice that of 2018-2019Investors said，The market is currently showing resilience，This is because since the epidemic，The global financial system is flush with cash，But further cuts in the future are becoming more severe.

Jay Barry, co-head of U.S. interest rate strategy at JPMorgan Chase, said:

"Another $1 trillion reduction in the balance sheet could have a bigger impact. When the first trillion is reduced，The federal funds rate rose rapidly; the $2 trillion impact was even greater，Because it comes at a time when the supply of government bonds is rapidly increasing. "

The Fed aims to cut another $1.50 trillion from its balance sheet by mid-2025，The US government has significantly increased its debt issuance，Demand from foreign investors is also weakening, which could push up borrowing costs for governments and businesses，And it will cause losses to many investors，They've been buying bonds this year.，Expect yields to fall as the rate hike cycle comes to an end.

International monetary fund (IMF) senior economist Manmohan Singh said，If we cut 1 trillion dollars，That would be equivalent to raising the federal funds rate by another 0.15 to 0.25 percentage points. He said: "As interest rates stabilize，The impact of more quantitative easing may become more apparent. "

this year，US Treasury increases bond issuance，To fill the gap between lower tax revenues and higher government spending. Earlier this month，The Ministry of Finance has announced that it will increase the size of its bond auctions for the next quarter，And will expand further in the coming quarters. The U.S. debt situation has triggered a downgrade by Fitch. Meghan Swiber, a rates analyst at Bank of America, estimates，Some auction sizes could reach the peak of epidemic lending in 2021.

At the same time，Japan is the largest foreign holder of U.S. Treasury bonds，Demand is expected to decline. The Bank of Japan eased its policy on yield curve control (YCC) in July, fine-tuning it，The rise in bond yields, which pushed Japanese government bond yields to their highest levels in nearly a decade, has led some investors to expect a massive return of Japanese money，Withdraw U.S. debt. Last month's TIC report showed，In May, China's (excluding Hong Kong, Macao and Taiwan) holdings of U.S. debt fell to $846.70 billion，$22.20 billion less than 4 month-on-month，Positions are approaching their lowest level since May 2010.

Even in this case，Quantitative tightening is also not expected to cause a liquidity crisis like it did in 2019. Unlike four years ago，There is still a lot of cash in the financial system. Although usage has declined，But the Fed's Reverse Repo Facility, which is designed to suck up excess cash, still keeps investors pumping in $1.80 trillion a night，Bank reserves have declined，But it remains well above the level the Fed fears.

But some analysts believe that，Yields in the U.S. Treasury market could rise sharply，Especially on longer-maturity bonds. Higher yields reflect lower prices. Barry said:

"The Federal Reserve's tapering，Even passive，Should also lead to a steeper yield curve. even though we are over hiking rates，Quantitative tightening could still affect the yield curve for the rest of this year and next year. "

Due to the fact that government bond yields are the basis for the valuation of various assets，Its sharp rise means that the cost of corporate borrowing has risen，This could dampen the rise in stocks this year.

Scott Skyrm, a repo trader at Curvature Securities, said，With bond issuance increasing in September and October，Then the market volatility will be even greater.