Quantitative Tightening

Quantitative tightening (QT) is the process by which the central bank shrinks its balance sheet, reversing the effects of quantitative easing. Rather than selling bonds outright, the Fed typically lets securities mature and does not reinvest the proceeds.

The effect is the mirror image of QE:

• As the Fed steps back as a buyer, the private market must absorb more Treasury and MBS supply
• This increases the term premium, pushing long-term yields higher
• Financial conditions tighten as the "portfolio rebalancing" effect of QE unwinds

The Fed has conducted QT twice:

• QT1 (2017-2019): reduced the balance sheet by approximately $700 billion before halting due to repo market stress in September 2019
• QT2 (2022-present): began allowing up to $95 billion/month to run off ($60B Treasuries + $35B MBS)

QT's impact on the curve is more diffuse than rate hikes. It operates primarily through the term premium rather than the expectations channel, making it harder to calibrate and communicate. The Fed has described QT as "running in the background" — a passive tightening that complements active rate policy.

The blog posts "The End of the Hedge" and "The Yield Curve Predicted a Recession That Never Came" discuss how QT contributed to the 2023 bear steepener and the divergence between curve signals and economic outcomes.