What Does the End of Quantitative Tightening Mean for Credit Unions?

In the aftermath of the COVID pandemic, the Federal Reserve’s balance sheet ballooned as policymakers utilized quantitative easing (QE) to inject liquidity into financial markets.  This meant that the Fed purchased hundreds of billions of dollars in Treasury and Agency securities, which created additional reserves in the banking system.  In early 2022, the Fed reversed course, as the economy no longer needed the extra support.  Since then, the Fed’s assets have shrunk from a peak of $9 trillion to the current level of $6.6 trillion.  This run-off of the Fed’s assets has been coined Quantitative Tightening, or QT. 

Recent stresses in short-term funding markets convinced Fed policymakers to bring an end to QT, as the amount of reserves in the banking system was getting low enough to impact market rates.  One straightforward way to view this increased stress is the spread between overnight SOFR (an interest rate based on actual market transactions) and the Fed’s target overnight Fed Funds rate.  This summer, SOFR regularly traded 5-10 bps above the lower bound of the Fed’s target range.  In recent weeks, this spread has more than doubled, with SOFR pricing on some days completely above the Fed’s 25 bps target range. 

The Fed’s decision to stop allowing their balance sheet to shrink on December 1 means that they will need to begin purchasing more investments, specifically Treasuries, to replace any maturities or pay downs in their portfolio. 

This policy move has three primary implications for credit union investors.   

1. The higher spreads on market-based rates like SOFR will stabilize and could actually decline in coming weeks.  For investors in floating rate securities which are tied to SOFR, it is very possible that yields on those securities will decline by 5-10 bps solely because the liquidity situation in financial markets will stop getting worse 

1. The Fed’s purchase of Treasuries could push UST yields down.  This effect is a bit less certain as the supply of Treasury bonds depends on the issuance needs of the federal government.  But the existence of the Fed as a new large buyer in the market will likely depress market rates on the margin 

1. The stability (or possible decline) in market-based rates could result in lower rates being available in wholesale funding channels.  Many of these rates, like FHLB and corporate credit union advances, are tied to these types of market rates 

Overall, the impact of the Fed’s end of QT will be modest for most credit unions as the companion move lower in the Fed’s target overnight rate will have a larger impact on CUs.  A lower interest rate environment will push projected income lower for most credit unions as lower yields on overnight rates won’t fully flow through to liability pricing.  The positive side of a lower rate environment is that lending opportunities could increase as loan payments become more affordable to many Americans due to the rate reductions. 

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.