Will the Fed Officially Announce the End of QT Tomorrow Evening?

Signs indicate that a sizable block trade emerged in the US interest rate market late last week, seemingly positioning for the Federal Reserve potentially announcing the end of its balance sheet reduction plan (Quantitative Tightening, QT).

Data shows SOFR is currently at 4.24% – this rate represents the overnight borrowing cost for short-term cash primarily collateralized by Treasury securities, reflecting the financing cost in the overnight repo market. The federal funds rate currently stands at 4.11% – this is the cost of unsecured overnight loans that banks charge each other to meet reserve requirements.

In essence, this trade is betting that if the Fed announces a tapering of its QT plan at its two-day meeting this week and implements an expected 25 basis point rate cut, the average SOFR for November would fall to 3.95% or lower, while the federal funds rate would be at 3.86% (4.11% - 0.25%) or higher.

This contrasts sharply with forward market expectations – one-month forward contracts last Friday showed traders expect SOFR to be 10 basis points above the federal funds rate by the end of November, which would be a record spread level, indicating that repo financing conditions remain tight.

Steven Zeng, US interest rate strategist at Deutsche Bank, said this is a trade betting that the Fed will halt QT this week and announce new policies to calm funding markets, which would cause the SOFR spread relative to the federal funds rate to narrow from current levels. He stated, "Although CPI growth remains at 3%, the latest inflation data we received last week came in slightly lower than expected."

Fed Chair Powell said on October 14 that the Fed is prepared to end QT, citing reasons including tightening liquidity conditions and strengthening repo rates.