VIEW: BofA Tweak QT Call Post-Logan

Bank of America note that “Fed communication from the December FOMC minutes and Dallas Fed President Logan's speech Saturday point to an early slowing of Fed QT.”

• “The most important line on QT from Logan's speech: "we should slow the pace of runoff as ON RRP balances approach a low level".”
• “What defines "a low level"? Logan did not specify but we might guess it is ON RRP at $200-250b. Our logic on the $200-250b level: (1) it represents ~10% of peak ON RRP use (2) since mid Sept '23 the standard dev of daily ON RRP changes is $60b which means a 3-4 st dev move could take ON RRP to zero. Both these considerations imply a relatively "low level" of ON RRP balances.”
• “The Fed ON RRP could reach a "low level" between March & June '24. Our logic: (1) Fed ON RRP balance is currently ~$700b & recent trend of ON RRP reduction since mid-Sept '23 has been $200b/m, if current trend holds the "low level" of $200-250b could be reached in March (2) our ON RRP projections show a slower pace of ON RRP decline at $100b/m which would see the "low level" of $200-250b reached in June '24. Risks are skewed to a more rapid pace of ON RRP decline.”
• “The BofA base case is now that the Fed will cut the monthly UST redemption cap by $15bn/m starting in Mar with QT ending in July. Other Fed QT taper options. Once QT ends, Fed should reinvest most MBS repayments into USTs.”
• “Impact of an early QT slowing = wider swap spreads & SOFR/FF because less UST private sector supply & potentially more UST demand (via Fed MBS reinvestment into USTs). Swap spread widening expected to be most pronounced in shorter tenors; SOFR/FF widening concentrated in 2H '24 & '25 tenors. It may also benefit a SOFR/FF 6m vs 1Y steepening w/ near-term higher SOFR risk but medium-term funding stability.”