Central banks’ QT rethink is blessing in disguise

Zions Bancorporation, National Association

17/10/2025 09:37

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Jon Sindreu

LONDON, Oct 17 (Reuters Breakingviews) - The world’s top central banks have spent three years trying to slim down their bloated balance sheets. But comments by Federal Reserve Chair Jerome Powell on Tuesday suggest that the attempt to return monetary policy to its pre-2008 norm by shedding bonds acquired through quantitative easing programmes may soon end. It should come as a relief to markets, because this is a diet with murky health benefits.

Central bankers have been cutting back the portfolios they built up during the post-Lehman financial crisis and pandemic by letting bonds mature or even, as in the case of the Bank of England (BoE), selling them outright. But the Bank of Canada announced a stop to such quantitative tightening (QT) in January and last month the BoE said it will only reduce its gilt stockpile by 70 billion pounds over the next year, down from 100 billion pounds the year before. The European Central Bank (ECB) has also slowed the pace of asset reduction. Powell on Tuesday suggested the Fed could stop letting its more than $6 trillion of government and mortgage bonds run off “in coming months.”

That suggests QT may end with central-bank balance sheets remaining far larger than they used to be. Even if the Fed and the ECB were to carry on shrinking at the current pace for a year, they would still have roughly $6.2 trillion and 6 trillion euros in assets respectively, which would make their balance sheets 48% and 27% larger than at the start of the pandemic and seven times and four times bigger than at the end of 2007. In the UK, investors polled by the BoE expect the central bank’s Asset Purchase Facility, created in 2009, to still hold 353 billion pounds in gilts by September 2029.

Ratesetters dislike holding large bond portfolios, because they can lead to losses if inflation spikes and central banks have to raise rates above the yield paid by the debt they hold, as has happened in recent years. Yet it’s debatable how much such losses matter, given central banks are not in danger of going bankrupt. And actively selling bonds when yields are high and prices low and thus locking in certain losses, as the Bank of England has been doing, makes even less sense.

The Fed has another concern. Printing so much money has meant that interest rates are no longer set by the central bank charging lenders for liquidity, as before 2008, but by it paying interest on the excess cash held by financial firms. This has crowded banks out of a big chunk of money-market lending, which the Fed hopes will reverse if money becomes scarce again. Whenever a bond held by a central bank matures, the cash that serves as payment for the principal is drained from the market.

But U.S. officials don’t want to return to the old system either, fearing that strict banking rules and a volatile economy have made demand for liquid assets stronger and less predictable. Powell said Tuesday that QT will stop short of the point where the market no longer has “ample” access to reserves. Even so, concerns about the health of U.S. regional banks, fuelled on Thursday by Zions Bancorporation ZION.O disclosing unexpected losses on two loans, are already coinciding with a jump in secured money-market rates – raising disquieting parallels with ructions in the same area in 2019.

Meanwhile, QT has other side effects. It forces the government-bond market, which is already on thin ice, to absorb more securities. In the UK, a volatile gilt market ousted Prime Minister Liz Truss in 2022 and is now troubling Chancellor Rachel Reeves. The British government’s 30-year borrowing costs have remained stuck around 5.3% this year, even as rate cuts by the BoE have led two-year bond yields to fall from 4.4% to 3.9%. In the U.S., investors now demand a 50 basis point “term premium” over expected cash returns to hold 10-year bonds. This premium was negative little more than a year ago.

QT has only played a small role in these moves, but it makes investors more wary of long-dated government debt. Markets should still welcome tightening, officials say, because without returning bonds to the market, there may not be enough available to resume purchases when the next crisis hits.

Yet that argument also doesn’t stack up. The experience of the past 17 years teaches that, if investors are in a panic and want to dump bonds, central banks should indeed take the other side. But in periods when the economy was sclerotic and investors were hogging safe assets, trying to outbid them did little to stimulate growth, and so gaining headroom now seems pointless. Though bingeing on those bonds brought little reward in hindsight, the urge to purge them is also better resisted.

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CONTEXT NEWS

Federal Reserve Chair Jerome Powell said on October 14 that the central bank’s long-running effort to shrink the size of its asset portfolio, known as quantitative tightening, or QT, may end in coming months.

U.S. officials have been letting the Fed’s $6 trillion portfolio of bonds mature without replacing them in a bid to drain the excess liquidity that years of massive asset purchases injected into money markets. That would then allow the Federal Reserve to control short-term rates by charging banks for deposits. Powell suggested on October 14 that increases in interbank secured borrowing rates indicated that the market is getting closer to this scenario.

These rates have risen further since, amid concerns about the health of regional banks that were heightened by a gloomy report by Zions Bancorporation on October 16.

Central banks still hold more assets than before the pandemic https://www.reuters.com/graphics/BRV-BRV/znvnnwgydvl/chart.png

(Editing by George Hay; Production by Oliver Taslic)

((Jon.Sindreu@thomsonreuters.com))