While so much attention has been paid to rate hikes, the Fed is also reducing its balance sheet with quantitative tightening (QT). They let bonds mature and not buying new ones. The money the Treasury pays to the Fed when bonds mature simply disappears. It’s a reduction in the base money supply and a form of monetary tightening. Under the Fed’s new Bank Term Funding Program (BTFP) created as part of the response to the SVB collapse, the Fed will take unlimited amounts of U.S. government securities from banks and provide cash loans at par value even if the bonds are worth far less as many are. The BTFP is designed to provide liquidity to banks without the banks having to sell bonds in the open market and realize losses that destroy capital.
But where does all the cash come from to make these loans? The answer is straight forward. As usual in the past, the Fed simply prints it! That’s what we call quantitative easing (QE).
So, the Fed is doing QT by letting bonds mature and doing QE at the same time by printing cash to bail out the banks. We call this contradictory policy QT+QE and it is a form of monetary easing compared to doing QT alone.
The Fed was comfortable raising rates yesterday and will be again in May because it runs it QE program behind the stage in response to the banking crisis.
But will this work? The banking crisis will continue with or without rate cuts. The recession will get worse with or without rate hikes. The fundamental forces behind economic growth and global liquidity are bigger than the Fed.