Fed to end "Quantitative Tightening (QT)" in October? This investment bank believes the Fed might even "expand its balance sheet"!

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As the market widely expects that the Federal Reserve may announce the end of its quantitative tightening (QT) policy at its meeting this Thursday, Bank of America believes that, due to increasing pressure on the money market's liquidity, the Fed may supplement bank system reserves by purchasing U.S. Treasuries or launching Term Open Market Operations (TOMO).

Bank of America analysts Mark Cabana and Katie Craig stated in a report released on the 27th that the only way for the Fed to rebuild “ample” reserves is to increase liquidity. The bank expects the Fed to launch overnight and term repo operations at the October FOMC meeting, with rates set 5 and 10 basis points above the interest on excess reserves (IOR), respectively, and a scale of $500 billion.

This expectation stems from recent signals of financing pressure in the money market. Bank of America points out that the Fed needs to take action to prevent excessive reserve depletion and avoid a repeat of the intense repo market volatility seen in 2019.

This move could have multiple impacts on the market, including widening the SOFR and federal funds rate spread, supporting the 2–5 year swap spread, and possibly being interpreted by risk assets as a signal of monetary easing.

Timetable for Ending QT: Possibly Announced Next Week

Bank of America stated in its research report that it expects the Fed to announce the end of QT at the October FOMC meeting. At the same time, the Fed will launch a plan to use agency MBS reinvestments to purchase Treasuries.

The bank believes that purchases of Treasuries will mainly come from the reinvestment of maturing MBS, but the Fed may also use this as an excuse to supplement bank system reserves. This “balance sheet expansion” will offset the absorption of market liquidity caused by larger-scale Treasury issuance.

Bank of America emphasizes that, although Permanent Open Market Operations (POMO) are the most robust solution, they may appear too aggressive for some Fed officials. Therefore, term open market operations have become a more likely “compromise.”

TOMO Operations: A Replay of 2019

Bank of America currently expects that the Fed will take TOMO “half-measures” as the base scenario. Specifically, the Fed will launch overnight repo operations at the October FOMC meeting, with a rate 5 basis points above the IOR; 14-day term repo operations will have a rate 10 basis points above the IOR, with a size set at $500 billion (effectively unlimited). At the same time, the Fed will lower the IOR by 5 basis points.

This arrangement draws on operational experience from 2019. That year, after repo market volatility, the Fed initially rolled out TOMO operations equal to the IOR with a $75 billion size, then progressively introduced term TOMOs and POMOs. Bank of America believes that the history of 2019 will repeat in 2025.

The bank explains that the main difference between TOMO and the Standing Repo Facility (SRF) is the scope of counterparties—SRF is open to primary dealers and depository institutions, while TOMO is only for primary dealers. For banks, using the SRF carries a stronger “stigma effect.”

Market Impact: Wider Spreads and a Boost for Risk Assets

According to Bank of America, TOMO operations at 5 basis points above the IOR will limit the upward movement of SOFR and the triparty general collateral repo rate (TGCR). This should widen the SOFR and fed funds rate spread (especially from November to January of the following year) and support the 2–5 year swap spread.

Risk assets may view TOMO or POMO as signals of financial repression and renewed risk appetite. The bank suggests investors maintain long positions in the January SOFR/federal funds rate spread.

Bank of America also notes that the biggest client skepticism is: the Fed’s definition of “ample” reserves has changed, the Fed is willing to accept repo rates above IOR, and can increase banks’ incentives to participate in repos by lowering IOR. In response, Bank of America argues that banks have no excess cash to lend; lowering IOR would only cause repos to reach the SRF ceiling more quickly, and the lesson of 2019 warns against excessively draining liquidity again.

Risk Warning and DisclaimerThe market carries risks, and investment should be made with caution. This article does not constitute personal investment advice, nor does it take into account the specific investment objectives, financial situation, or needs of any particular user. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Investment based on this article is at your own risk. ```