Fed Expected to Pause Balance Sheet Reduction as Liquidity Pressures Mount

Several major Wall Street analysts now expect the U.S. Federal Reserve to pause its balance sheet reduction program—commonly known as quantitative tightening (QT)—as early as this month. The move comes amid signs of renewed turbulence in money markets, where short-term funding rates have started to climb and bank demand for liquidity through the Fed’s repo operations has increased. The tightening of financial conditions suggests that the banking system may be approaching the lower limit of “ample reserves,” the level the Fed aims to maintain to keep short-term rates stable.

The Fed has been gradually shrinking its $9 trillion balance sheet since 2022, allowing Treasury and mortgage-backed securities to mature without reinvestment. While the process was initially seen as a gradual and manageable normalization of liquidity, market dynamics have recently shifted. Rising repo rates and increased use of the Standing Repo Facility indicate that reserves in the system are becoming scarce—a sign that continued balance sheet runoff could strain financial stability. Analysts at major firms including Jefferies, Evercore ISI, and Wrightson ICAP believe the Fed may soon signal a formal slowdown or halt to QT to prevent a repeat of the 2019 funding squeeze that disrupted short-term money markets.

A potential QT pause could have broad implications for asset prices. Equities and risk assets might benefit from renewed liquidity support, as fewer Treasuries flow back into private markets and yields ease off recent highs. Conversely, such a decision could also raise questions about the health of the financial system—suggesting that liquidity stress, not economic strength, is driving policy shifts. For bond investors, a halt would likely reduce supply pressure, potentially flattening the yield curve and anchoring long-term rates.

Beyond market mechanics, the debate highlights a deeper issue: the balance between monetary policy normalization and financial stability. The Fed’s objective of maintaining “ample reserves” while curbing inflation has proven delicate, especially as fiscal deficits remain large and global capital flows fluctuate. Should QT end prematurely, it would signal that the Fed prioritizes market functioning and liquidity over continuing its tightening cycle.

In essence, this potential pivot represents more than just a technical adjustment—it reflects the Fed’s ongoing struggle to manage liquidity without triggering instability. For investors, the implications are clear: while a pause in QT could boost short-term confidence and support risk assets, it also underscores how dependent the U.S. financial system has become on central bank liquidity.