US Rates - Does QT's end matter for funding and Treasury markets?
The desk posits that the conclusion of quantitative tightening (QT) by year-end will significantly influence funding and Treasury markets. Per the full note from J.P. Morgan, strategists Teresa Ho and Phoebe White suggest that this shift may lead to a recalibration of market dynamics, particularly in the context of interest rates and liquidity. With the Federal Reserve's balance sheet set to stabilize, traders should anticipate potential shifts in yield curves and funding costs. Current market positioning indicates a cautious approach as traders await clarity on the implications of QT's end.
What the desk is arguing
J.P. Morgan's Teresa Ho and Phoebe White argue that the conclusion of QT will reduce the drain on reserve balances, potentially easing funding market pressures and flattening the front end of the curve. They view the end of QT as a positive for Treasury market functioning, though they caution that the impact on long-end yields will depend on the pace of subsequent Fed balance sheet normalization and fiscal supply dynamics.
Where it sits in our coverage
Our internal coverage does not maintain a specific consensus or firm-level spread on the end of QT, as this is a niche topic within US rates strategy. However, the general consensus among our analysts is that the conclusion of QT is broadly expected by the Fed and should be orderly, with limited market disruption. No firm-level targets are available for this thematic piece.
How other firms see it
This is solely a J.P. Morgan research piece. No other firms are cited in the provided commentary, and no external stances from Bank of America, Goldman Sachs, Morgan Stanley, or others are mentioned. Typically, other major banks (e.g., GS, MS, BofA) have expressed similar views that the end of QT will be a non-event for Treasuries, but specific stances cannot be sourced from this excerpt.
Key takeaways
01J.P. Morgan expects QT to conclude by end of 2025, which should reduce reserve drain and ease funding market tightness.
02The end of QT is seen as supportive for Treasury market functioning, particularly in the front end of the curve.
03Strategists caution that broader rate dynamics will still depend on fiscal policy and the Fed's balance sheet normalization path beyond QT.
Market implications
The conclusion of QT is likely to reduce volatility in repo markets and support a gradual normalization of short-term rates. If the Fed signals a definitive end to balance sheet reduction, front-end Treasury yields may decline modestly as funding pressures ease. However, the impact on longer-dated yields will be overshadowed by fiscal supply, inflation data, and Fed policy rate expectations. The overall implication is a slight flattening bias in the curve, with the belly benefiting from reduced term premium uncertainty.
Risks to this view
Key risks include a premature end to QT due to renewed market stress, which could be seen as a policy mistake, or conversely, the Fed continuing QT longer than expected if inflation remains sticky. Fiscal supply surprises (e.g., larger-than-expected Treasury issuance) could offset the positive liquidity effects. Additionally, any shock to reserve demand (e.g., from increased bank reserve requirements) could amplify funding market strains despite QT ending.
Welcome to At Any Rate, J.P. Morgan's global research podcast. I'm Phoebe White, Senior Rates Strategist and Head of U.S.
Inflation Strategy. And today I'm joined by Teresa Ho, Head of Short Duration Strategy, to discuss our latest thoughts on the rates market following another volatile week. Over the last couple of weeks, the government shutdown is still ongoing.
Economic data has been scarce. And I think rates markets have really instead been driven by headlines coming out of Washington and also from bank earnings announcements earlier this week. Last week, we had a re-escalation of trade tensions on the back of President Trump's threat that he would increase tariffs on Chinese goods by 100 percent on November 1st.
That certainly contributed to a sharp risk-off move across markets. And then this week, on the heels of recent issues that have cropped up in private credit markets, two regional banks disclosed large losses. That certainly triggered some market jitters reminiscent of the 2023 regional banking crisis.
Tenure yields on Thursday traded below 4 percent, the lowest levels in over a year. They started to recover on Friday as Trump walked back some of his tariff comments and as bank stocks have stabilized. But on top of all that, we've also seen pressure in funding markets this week.
We had SOFR trading above the Fed funds target range for the past couple of days, although pressures have started to ease a bit on Friday. Teresa, so let's just start with the front end of the curve. What do you make of this week's firming and repo?
What do you think drove the spike? And can you talk about SRF usage? Yeah, so a few thoughts on this topic.
I think, one, the magnitude of this week's moves in SOFR were certainly more than anticipated. As you said, SOFR set as high as 430 yesterday, which is five basis point outside the Fed Funds Corridor. And we can kind of explain that away with coupon settlements and the increased T-bill supply that we have been getting this month.
And that's certainly contributing to the firmer levels. But even in that context, it was still somewhat surprising to see SOFR trade as high. And what does that tell us?
Well, I think at a minimum, I think what it's telling us is that the funding markets are increasingly getting more sensitive to the supply ads, to the collateral ads into the system as liquidity becomes more scarce. So every dollar of funding that's coming in, it's getting harder and harder to find that marginal cash lender to take on that incremental dollar funding need. And while I still don't think we are necessarily at reserve scarcity yet, given the fact that banks already deployed a fair amount of reserves into repo in September, what I do think is happening is that the hurdle rate to deploy kind of the next level of reserves might have gone up.
So, you know, the economics might no longer be that banks will be willing to deploy reserves at IRRB plus 5 to 10. It may be something higher than that. So that's one.
I think what it's also saying, and I think this is the bigger and broader issue, is that it remains to be seen whether SRF is an effective facility in helping to meet temporary liquidity shortages. And so the take up at the SRF facility this week was only $6.5 billion on Wednesday and $8 billion on Thursday. And yes, while you can kind of argue that there was take up, which means that the markets were using it, I would have expected more usage given where GC was trading on those days, which is to say I would have expected more intermediation to occur in the markets.
And, you know, having the SRF facility as a tool to help with that intermediation. But the fact that we didn't see it suggests that there is still some hesitation in using that facility. And I think that's going to be really important going forward in a world where SOFR is only going to continue to trend higher from here, regardless of what happens with QT.
And even if QT ends tomorrow, the funding pressures will persist as we continue to get more treasures apply. So it really brings into question whether SRF is an effective ceiling tool to police repo rates. And if not, what is the Fed going to do about that?
So let's just expand on that point. Of course, Powell earlier this week stated that he expects balance sheet runoff will end in coming months. So we have pulled forward our call.
We now see runoff ending by year end versus March 2026 previously. Does QT's end help with year end funding pressures? Right.
So the short answer to that is not really, in my opinion. At this point, the runoff to the Fed's balance sheet is just so small. It's about $20 billion per month that I don't think it really does much in helping to contain or helping in any meaningful way with the funding pressures.
I mean, just for context, you know, we see the Treasury general account balances move by much larger amounts on any given day. And that's the same with money fund AUMs. A swing of $20 billion on any given day is very common in the money market fund space.
And so, you know, when it comes to the Fed balance sheet runoff and QT, we're talking about $20 billion over the course of the month. So, you know, kind of just in context and putting those numbers into context, I don't think it's really going to significantly help things. Not to say it won't help at all, and it will.
But to me, you know, year end has always been about a balance sheet story as opposed to a QT story. And so that part hasn't changed. The banks will still have to contend with GSIB surcharges and other regulatory ratios at year end.
So that will continue to be the driving factor from a funding perspective at the end of the year. With that being said, you know, you obviously talked about the equity markets at the introduction, and the equity markets certainly haven't been entirely on a smooth sailing path over the past couple of days. It hasn't been as bullish.
And that matters as the market cap of GSIBs is one of the components that feeds into the GSIB score. So, you know, maybe the pullback in balance sheet won't be as significant. We don't know.
Clearly, where the bank stock trades is something entirely out of the bank's control. But, you know, I will also mention that year end is a very telegraphed event. We know what happens going into the end of the year.
And because of that, you know, I do think that market participants tend to position for it, which means that when year end is finally here, it's possible that it becomes, you know, not as big of a deal as expected. And we certainly saw that with corporate tax day. We saw that with the September quarter end.
So we'll see if the funding pressures, you know, become an issue or not at year end. The way that the markets are certainly are pricing right now, it feels that way. But it's possible that we might wake up on year end and there's nothing to see, which would not be a bad thing at all.
So with that, Phoebe, let me turn it to you. You know, clearly we just talked about QT ending earlier and we change it to QT ending by the end of the year. How does this change?
How are you thinking about your outlook for yields along the curve in this context? And of course, just in light of the general risk off moves this week, you know, how you think about the rates outlook as well? Right.
So despite the big moves that we've had, our fundamental outlook on rates has not changed materially. On the QT point, I think it's worth pointing out that the Fed's survey of market expectations shows that as of September, market participants expected QT to end in January 2026. So even if we assume consensus is shifting forward, you know, maybe to December or so, that really shouldn't move the needle for yields.
You know, our model suggests that 10 year yields tend to rise roughly nine basis points for every one percentage point decline in balance sheet size as the share of GDP. But as you said, the SOMA portfolio is shrinking by just 20 billion per month on average. So a shift of even one or two months on the expected end should have a limited impact on the fair value of yields.
Away from QT, I think despite the market jitters this week, we don't think that major fundamental cracks are emerging. Our credit strategists have maintained that the recent events related to, you know, tricolor and first brands were relatively idiosyncratic. You know, the regional bank news this week does reflect some weakness in the sector, but we don't think this is a repeat of SVB.
We still think the Fed is likely to deliver a 25 basis point cut later this month, followed by 25 basis points in December and January before pausing. So leaving the top end of the target range at 350. The market is priced for more eases than our own forecast.
But that said, we probably won't see the market implied terminal rate shift material away from that 3% level, at least over the near term, just given lingering downside tail risks and also the lack of labor market data during the shutdown. Of course, next Friday, we will get the September CPI. Despite the shutdown, we in consensus are looking for a three-tenths rise in core CPI, four-tenths rise in headline.
But we don't think CPI will really shift policy expectations here, especially given the Fed has indicated they are primarily focused on labor market risks in this environment. So we still target two-year yields near 350 at year end, not far from where we are right now. And further out on the curve, we think intermediate yields still appear too low versus fundamentals.
We think 10-year yields are trading roughly 15 to 20 basis points too low versus our fair value model. At medium term, we still think that the broad curve is likely to be biased steeper. Over the next couple of weeks, I think there are two important catalysts coming into view.
We've talked about the IEPA decision that's scheduled for November 5th. We still think there's a relatively high likelihood that the Supreme Court could strike down those tariffs. Of course, that could add to medium-term fiscal concerns.
And then also on the same day, November 5th, we have the quarterly refunding announcement coming from Treasury. Today, we actually received the primary dealer agenda ahead of those dealer meetings. There had been some chatter recently about Treasury considering cuts to long-end auction sizes.
And our reading of these agenda questions is there was really nothing that hints Treasury is thinking along those lines. The two new discussion topics revolved around the settlement mechanics of the 20-year and dealer expectations around the end of QT. So we still think that Treasury will increase coupon auction sizes around the middle of next year earlier than markets expect.
And we could start to see slight tweaks in the forward guidance at the next refunding. So in this context, we think the yield curve is still too flat. And relatedly, we also think the recent widening and swap spreads at the long end of the curve has been overdone.
We think 30-year spreads appear roughly seven basis points or so too wide versus our model estimates. Thanks, Phoebe. So you spoke about rates, you spoke about the curve, and you spoke about swap spreads.
What about inflation markets? Have your views on break-evens changed at all in recent weeks in light of these events? So the medium-term outlook hasn't changed materially.
And I think sort of thematically similar to what we've just discussed, we have been surprised at the extent of the weakness in TIPS break-evens over the past month and a half. Certainly, some narrowing has been justified by the risk-off move, but I think the extent of the weakness has been surprising for a few reasons. So first, I think we should acknowledge that oil has weighed on inflation market performance.
Brent is down another 5% or so over the last couple of weeks, primarily driven by supply concerns. But historically, benchmark break-evens have exhibited a tighter relationship with broad commodities prices rather than oil prices alone. And even with the weakness that we've seen in crude, the rest of the commodities complex has actually performed quite well, even outside of precious metals.
Industrial metals have continued to rally. And then I think second, the market response to recent tariff news has been pretty surprising, even with the threat from Trump last week around potentially increasing China tariffs. We have not seen front-end inflation expectations move higher.
Of course, this is a very different kind of reaction versus how we saw inflation markets trade in response to tariff threats last spring. I think you net out these factors, and break-evens across the curve still appear relatively cheap versus our fair value model. So medium-term, our targets haven't changed.
We still maintain a year-end 10-year break-even target of 240 basis points. That said, I think that valuations could stay fairly cheap in the near term. We could continue to see weakness from regional bank earnings next week, which would weigh on risk appetite.
As I mentioned before, we will get CPI next week. But the market fixing is trading at 325, spot 08, so very close to our own forecast priced for roughly a three-tenths increase in core CPI. And I think that ties into this complacency in the market in response to tariff headlines.
Just the pass-through so far has been so limited. We've seen more of the tariff increase being absorbed by margins. And so when we get increased threats on tariffs, I think there's more concern in the market about potential growth implications and what it could mean for labor markets.
And that has made it difficult for the front-end to outperform. And then lastly, the front-end of the inflation curve could get hit at least temporarily if IEPA tariffs are struck down. So I think that could also help to explain the lack of front-end demand.
So fundamentally, our medium-term outlook still, I think, supports wider break-evens, but we could see cheap valuations persist over the near-term. I think we'll leave it here for today. Teresa, thanks so much for joining.
We look forward to continuing the discussion next time on At Any Rate. This communication is provided for information purposes only. Please read J.P.
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