Last week, I noted that ongoing drain from the Fed’s RRP facility telegraphed the end of QT likely by the end of 2024.

More than a few observers, analysts and strategists have suggested the Fed should halt balance sheet runoff before RRP is completely drained. The definition of “abundant,” “ample” and “scarce” isn’t fixed. Nobody knows exactly where the reserve scarcity threshold is, and as we saw in September of 2019, it’s easy to step over that threshold accidentally to fairly dramatic effect.

In a note dated November 19, Goldman weighed in, suggesting the Fed will likely “begin considering changes to the speed of runoff” in Q3 of next year, before slowing the pace in Q4 and ultimately ending runoff in Q1 2025.

When runoff ends, Goldman expects reserves to be between 12-13% of bank assets and the Fed’s balance sheet to be around 22% of GDP, down ~7ppt from current levels and 4ppt above 2019 levels.

This is a critical debate for obvious reasons and it’ll become more topical in the months ahead.

You can, if you like, venture deep into the proverbial plumbing in search of — I don’t know — some kind of enlightenment or insight into arcana that might come in handy if you should find yourself stranded on a desert island with a STIR trader or a front-end strategist. But for our purposes here (where that means to add a little additional color to the brief discussion in the article linked above), the following short excerpts from Goldman’s piece, penned by Manuel Abecasis and Praveen Korapaty, will more than suffice.

To wit, from Abecasis and Korapaty:

In 2022, the bulk of the reduction in the Fed’s balance sheet came from a decline in bank reserves. At the same time, the Fed’s reverse repo facility increased as the rapid rise in the fed funds rate led depositors toward money market funds in search for more attractive yields and a decline in outstanding Treasury bills pushed money markets toward the RRP facility. In contrast, reserve balances have been relatively flat in 2023, and the Fed’s liabilities declined largely because of lower RRP use as increased Treasury bill issuance and higher demand for funding by banks pushed money market funds away from the facility. Looking ahead, we expect RRP balances to continue declining and reach near-zero levels in 2024 as these dynamics continue. Lower RRP balances account for the bulk of the decline in the Fed’s liabilities that we expect over the next year.

The FOMC will likely aim to stop balance sheet normalization when bank reserves go from “abundant” to “ample” — that is, when changes in the supply of reserves have a real but modest effect on short-term rates relative to the Fed’s administered rates. Our model suggests that short-term rates will start becoming more sensitive to changes in reserves around 2024Q3, and we expect the FOMC to begin considering changes to the speed of runoff at that point and then to slow the pace of balance sheet reduction in 2024Q4 by cutting the monthly runoff caps in half from $60bn to $30bn for Treasury securities and $35bn to $17.5bn for MBS securities. We expect runoff to finish in 2025Q1.

We continue to expect the Fed’s balance sheet runoff to have modest effects on interest rates, broader financial conditions, growth and inflation. Our rule of thumb derived from a range of studies is that 1% of GDP of balance sheet reduction is associated with a roughly 2bp rise in 10-year Treasury yields. In total, our projections for runoff imply that balance sheet normalization will have exerted around 20bp worth of upward pressure on 10-year yields since runoff started. Together with our rule of thumb that a 25bp boost to 10-year term premia from balance sheet reduction has roughly the same impact on financial conditions and growth as a 25bp rate hike, this implies that the total runoff process should have the effect of a little under one rate hike. At this point, a large part of runoff has already occurred and most of what remains is likely already anticipated by financial markets, meaning that most of the impact on Treasury yields is likely behind us.

The key risk to our forecast is that the increased supply of debt that we expect in 2024 causes intermediation bottlenecks in the Treasury market that lead the Fed to stop runoff earlier. Another possible risk is that FOMC participants decide to stop runoff early in order to avoid risking volatility in money markets.