Written by: White55, Mars Finance

On October 29, the Federal Reserve announced a 25 basis point interest rate cut, lowering the target range for the federal funds rate to 3.75% to 4.00%. This marks the fifth rate cut since September 2024. However, more intriguing than this market-expected decision is another announcement made by the Federal Reserve: it will end its balance sheet reduction plan starting December 1. This policy, known as quantitative tightening (QT), has reduced the size of the Federal Reserve's balance sheet from a peak of nearly $9 trillion during the pandemic to about $6.6 trillion since its initiation in 2022. Its conclusion signals a significant shift in the global liquidity environment.

Policy Shift: From Implicit Withdrawal to Gentle Injection

The essence of quantitative tightening is the Federal Reserve's method of quietly withdrawing liquidity from the financial system by allowing maturing bonds to expire without reinvestment. This policy began in June 2022, when the U.S. was grappling with high inflation, necessitating a coordinated effort from the Federal Reserve to tighten financial conditions. Over the past three years, QT and interest rate hikes have worked in tandem: raising the cost of funds while reducing their quantity. Since 2022, the Federal Reserve's balance sheet has significantly shrunk by allowing some bonds to mature without reinvestment. However, the situation is changing. In mid-October 2025, Powell warned during a speech in Philadelphia that there are signs of further cooling in the U.S. labor market. He also indicated that as liquidity conditions in the financial system gradually tighten, the QT plan may be nearing its end. The Federal Reserve has agreed to adopt a "very cautious" approach to avoid the kind of monetary market stress experienced in September 2019. Ending QT means the Federal Reserve will stop withdrawing liquidity from the financial system and will instead reinvest the proceeds from maturing securities, effectively re-injecting funds into the market. This shift appears to be a technical adjustment but has profound implications for market liquidity.

Decision Logic: Preventive Measures and Market Stabilization

Behind the Federal Reserve's decision is a cautious assessment of the economic outlook and considerations for market stability. Powell's message in October that "employment concerns outweigh inflation risks" became a key basis for the Federal Reserve's policy shift. Although inflation remains above the Federal Reserve's 2% target, long-term inflation expectations are still aligned with this target. The signs of cooling in the labor market are more pronounced, with Powell noting that "in this less active and somewhat weak labor market, the downside risks to employment seem to be rising." Federal Reserve policymakers acknowledge that the ongoing federal government "shutdown," which has lasted nearly a month, has constrained their decision-making process. The lack of official data makes it difficult for the Federal Reserve to accurately assess the current economic situation, and this uncertainty has prompted a more cautious policy stance. The decision to end QT also reflects the Federal Reserve's concern for market liquidity. The New York Fed conducted large-scale repurchase operations in September to alleviate liquidity pressures in the money market. These operations suggest that bank reserves may have fallen to near minimum comfort levels, and further balance sheet reduction could jeopardize market stability.

Market Impact: The Subtle Shift of Liquidity

The end of QT will have profound and complex effects on various assets. According to an analysis by Dong Zhongyun, chief economist at AVIC Securities, ending the balance sheet reduction may have three main impacts: first, market liquidity in the U.S. is expected to improve, avoiding a repeat of the 2019 repo market crisis; second, ending the balance sheet reduction means the Federal Reserve will stop reducing its bond holdings, alleviating selling pressure in the bond market and helping to lower long-term yields; third, ending the balance sheet reduction can enhance expectations for monetary policy easing, creating a synergistic effect with interest rate cuts. Despite the Federal Reserve announcing a rate cut on October 29, long-term Treasury yields have continued to rise. This seemingly counterintuitive phenomenon reveals a divergence in market expectations regarding future policy paths. Powell noted that there is "serious disagreement" among policymakers regarding actions in December, adding uncertainty to future policy directions. However, the end of QT may provide more direct support for the stock market. Ending QT means the pressure of liquidity withdrawal from the market is reduced, which will support U.S. stocks, particularly benefiting growth stocks and technology stocks that are sensitive to liquidity. This view aligns with that of Bill Adams, chief economist at Dallas Fed, who believes that the end of QT may "translate into more liquidity in financial markets and more private investment funds flowing into risk assets in the near future." Subtle Change: The "Implicit Rate Cut" Effect of Ending QT

Some analysts believe that even if the Federal Reserve pauses rate cuts in December, ending QT early may produce effects similar to a rate cut. John Luke Tyner, a portfolio manager at Aptus Capital Advisors in Alabama, even suggests that ending QT before 2026 could yield an effect equivalent to a 25 basis point rate cut for investors. This "implicit rate cut" effect is primarily realized through two channels: first, alleviating the fundamental pressure on bank reserves, and second, managing the supply and maturity structure of Treasury issuance. Ending QT means the Federal Reserve will absorb some Treasury supply from the private market, altering the supply-demand balance. However, not all analysts agree with this direct analogy. Derek Tang, an economist at Washington Policy Analysis, believes that the end of QT amplifies the impact of any rate cuts by "strengthening risk appetite in the stock market," but he views the Federal Reserve's actions more as a "gradual adjustment" of balance sheet policy. The decision to end QT is also closely related to the U.S. Treasury's debt issuance strategy. Will Compernolle, a macro strategist at FHN Financial, points out that after ending QT, the Treasury will have greater flexibility in bolstering its general account cash balance, while the Federal Reserve will become a "voluntary buyer, absorbing some Treasury demand."

Global Impact: The Spillover Effect of Dollar Liquidity

The Federal Reserve's shift in monetary policy is never just a domestic affair; its spillover effects will have profound implications for global capital markets. Historical experience shows that tightening U.S. monetary policy often coincides with financial crises in emerging markets or globally. However, the end of this round of QT may be beneficial for emerging markets. The Federal Reserve's cessation of quantitative tightening will alleviate the capital outflow pressures faced by emerging markets, helping to improve their external financing environment. As the pressure of tightening dollar liquidity eases, international capital may flow back into emerging markets in search of higher returns. The trajectory of the dollar index will also be affected. The narrowing interest rate differential between the U.S. and foreign countries due to rate cuts will further weaken the dollar's attractiveness, compounded by "de-dollarization" sentiments catalyzed by global trade frictions, increasing upward pressure on the dollar index. This assessment aligns with predictions from Franklin Templeton Investments, which expect inflation concerns to lead to a smaller-than-expected rate cut by the Federal Reserve, with the final target range for this round of policy rates likely above 3.5%. The commodity market may exhibit divergent trends. Gold may benefit from falling real interest rates and renewed safe-haven demand, potentially continuing to rise; however, oil prices will still be priced based on supply and demand fundamentals, with OPEC+ production cut compliance and Middle Eastern geopolitical risks remaining core variables determining the marginal direction of oil prices, making the impact of rate cuts likely relatively limited. Future Outlook: The Fog of Policy Path

Although QT is about to end, the future policy path of the Federal Reserve remains fraught with uncertainty. Powell stated at the press conference following the October meeting that there are significant disagreements among officials regarding how to act in December, and another rate cut at the December meeting is not a foregone conclusion. The schedule published on the Federal Reserve's official website indicates that there is one more rate meeting in 2025, with a new rate decision to be announced on December 11, Beijing time. This meeting will be more important as it may provide more clues for the policy path in 2026. Major institutions have differing predictions regarding the Federal Reserve's future policy direction. Morgan Stanley predicts that the Federal Reserve will continue to cut rates until January 2026, with two more cuts in April and July 2026, ultimately lowering the target range for the federal funds rate to 3.00% to 3.25%. In contrast, a research report from CICC suggests that under "natural circumstances," the Federal Reserve still has room for three more rate cuts, corresponding to long-term rates of 3.8% to 4.0%. The report also states that while the Federal Reserve still has some room for easing, the pace of rate cuts may slow, and overly optimistic expectations should be avoided. New uncertainties are also emerging. CICC points out that the new Federal Reserve chair and the independence of the Federal Reserve are the biggest variables for the rate cut path next year, which could increase policy uncertainty after the second quarter of 2026. This view suggests that political factors may have a greater impact on the future direction of monetary policy.

Money market funds have set a record of $7.42 trillion in assets, reflecting the market's thirst for returns and the pursuit of safe assets. After the end of QT, these dormant capital giants may readjust their allocations in search of new habitats. The Federal Reserve will terminate the QT plan on December 1, but Powell has also made it clear that another rate cut at the December meeting is not guaranteed. This cautious attitude itself serves as a mirror, reflecting the Federal Reserve's difficult balance between inflation and growth, data absence and policy foresight. The curtain on the liquidity feast has slowly risen, but the duration of the banquet and its ultimate effects will still depend on the final trajectory of the economic fundamentals.

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