QT Impact: Fed Paper Says ~50bp Equivalent In Hikes (1/2)

Federal Reserve Board staff economists published a note Jun 3 exploring " the substitutability between policy rate hikes and reductions in the size of the Federal Reserve's balance sheet for the removal of policy accommodation" - in other words, what is QT's equivalent in terms of rate hikes.

• The researchers conclude, based on the effect of changes in Fed asset holdings on bond term premiums (a 1% of GDP reduction in 10Y Tsy holdings raises term premia by 10bp), that a $2.1T (7.7% of GDP) reduction in the balance sheet by Q3 2024 as per the scheduled runoff pace, vs maintaining the size at its peak level, would be roughly equivalent to raising the policy rate by about 56bp on a sustained basis.
• This has been a key question, as some FOMC members have suggested they could weigh the tightening brought by QT against the need for Fed funds rate hikes (though emphasizing that the funds rate is their primary tool).
• Powell has said QT this year could be equivalent to tightening by around one 25bp hike.
• Fed VC Brainard noted in a CNBC interview last week that runoff could be equivalent to another 2 or 3 hikes (ie 50-75bp, in line with the Fed staff paper's estimate).
• There are several areas of uncertainty underlying these estimates. The only transmission channel of QT that is considered is via portfolio balance effects, and the authors stress "significant uncertainty" re the impact of QT on medium-to-longer-term rates and on the broader economy.