QT Is Ending—But Does That Mean QE Is Around the Corner?

The Federal Reserve is preparing to wrap up its balance-sheet reduction program—better known as quantitative tightening (QT)—on December 1. Since the process began, more than $2 trillion has rolled off the Fed’s balance sheet, largely through a steep decline in the overnight reverse repo facility. Recent instability in short-term funding markets, however, prompted policymakers to wind down QT sooner than previously expected.

But the end of QT doesn’t automatically signal the beginning of a new round of quantitative easing (QE). At least not immediately.

What Happens Next for the Fed’s Balance Sheet

Guidance from the New York Fed’s latest Market Operations Annual Report outlines what the next phase may look like. Once QT concludes, the balance sheet is expected to gradually expand again—not because of new stimulus programs, but due to natural growth in the demand for reserves and the continual rise in currency circulation.

Over time, the Fed expects its total assets to surpass prior peaks. If that occurs, the resulting increase in system-wide liquidity could offer support to risk assets across financial markets.

Why Reserve Demand Keeps Rising

The Fed often associates reserve demand with broad economic growth, but that connection is only part of the story. Banks must hold reserves to meet regulatory capital and liquidity requirements, and as the financial sector becomes larger and more complex, those reserve needs grow accordingly.

This means reserve demand is structurally anchored—not just tied to cycles in GDP—suggesting it will keep trending higher even if economic growth slows.

A Shift Toward a Treasury-Focused Portfolio

Another major development is the Fed’s long-term goal of holding nearly all Treasuries and significantly fewer mortgage-backed securities (MBS). Today, the Fed owns around $4.2 trillion in Treasuries and roughly $2.1 trillion in MBS. Over the next decade, officials aim to reduce the MBS share of the portfolio from one-third to about 10%.

During the maintenance and expansion period ahead, all principal payments from MBS will be reinvested into Treasuries—reinforcing this gradual realignment.

But Realignment Will Take Time

Even with this strategic shift, the Fed’s portfolio will not resemble the Treasury market anytime soon. The central bank remains heavily concentrated in longer-duration bonds, with nearly 38% of its holdings in maturities of 10 years or more—far above the roughly 18% weight in the overall market.

This tilt toward long-dated securities has echoes of “Operation Twist,” though the impact is softer since reinvestments are made at auction. Still, it raises the question of how the maturity distribution of Treasury issuance might have differed without sustained Fed demand at the long end.

The Challenge of Reducing MBS Holdings

MBS runoff will continue even after QT ends, likely keeping mortgage spreads somewhat elevated. While the investing case for MBS remains positive, tighter valuations limit some of the opportunity.

A major obstacle is the composition of the MBS portfolio itself. Much of the Fed’s exposure sits in long-maturity securities with extremely slow prepayment speeds, especially with mortgage rates still high. Many of these bonds don’t mature until 2051. Without refinancing activity or outright sales—which the Fed has not signaled—it could take decades for these holdings to decline meaningfully.

Bottom Line

The end of QT marks a turning point for Fed policy, but not the beginning of QE. Instead, the next phase is likely to involve a slow, steady balance-sheet expansion driven by organic reserve demand and the natural growth of currency in circulation.

For fixed income investors, these dynamics are modestly constructive. MBS spreads may remain under pressure, but growing liquidity and eventual balance-sheet expansion could lend support to Treasuries and other risk assets. Importantly, the Fed appears positioned to navigate this transition without a repeat of the 2019 funding-market stress that emerged during the previous QT cycle.

The path forward will be gradual, and the Fed’s portfolio will take years to align with market benchmarks—but the immediate risks tied to balance-sheet reduction have eased considerably.

READ MORE: https://www.lpl.com/research/blog/qt-is-ending-is-qe-next.html