Transcription
The Federal Reserve has officially ended quantitative tightening. And now that they have, here are a few things you should expect are going to happen next over the coming months and quarters.
This is a chart of the Federal Reserve's balance sheet. You can think of this like their brokerage account. When you have a brokerage account, you are going to buy and sell stocks with your brokerage account, which means whenever you make purchases, you're sending cash out into the financial system and you're receiving shares of the stock you're buying instead. This means that if you just look at you versus the entire rest of the financial system in the economy, every time you make a purchase, it's a liquidity injection. You're giving the economy your cash. But in exchange, you are receiving an asset. In your case, maybe it's a stock or an ETF. On the flip side, anytime you sell shares, you are giving the economy back those shares and you are withdrawing liquidity. You're taking cash away from the financial system.
This is exactly what the Federal Reserve does with their balance sheet. Whenever they buy assets, they are injecting cash into the economy and they are receiving assets that they have withdrawn out of the economy. That process is called quantitative easing. And if you look back at their balance sheet here, anytime the chart is headed higher, it is quantitative easing. They're adding assets to their balance sheet in exchange for cash that they have injected into the economy. The only difference, and it's a pretty big difference between you and the Fed in this case, is they are creating the dollars out of thin air that they are using to make those purchases. Which means anytime they are making purchases, it's actually increasing the net overall total liquidity and cash in the system. When you make a purchase, yes, the economy has more, but you have less. So, anytime the Fed's balance sheet is going up, that is QE. They're creating cash and sucking assets away from the financial system.
Now, anytime you see their balance sheet headed down, like in 2018 and ever since 2022, that is called quantitative tightening because they are letting assets bleed off of their balance sheet and then that cash disappears from the financial system. And this is because the assets the Fed holds are debt assets. So, as that debt gets paid back, what the Fed does with those dollars that get paid back to them, some of them just cease to exist and they get destroyed. So, QE, the balance sheet of the Fed is rising and the cash in the financial system is rising. QT, the balance sheet is declining and the cash in the financial system is declining.
As of December 1st, 2025, QT has officially ended, which means their balance sheet will no longer be headed down like it has been for the past couple of years. Instead, it will start moving sideways like it did from about the beginning of 2015 through the end of 2017. Now, there's a very specific reason why they are doing this, and it's not what you think. It's not because we have a financial crisis right around the corner. It's not even because we have a liquidity crisis right around the corner.
A lot of people recently have been talking about the reverse repo facility at the Fed and how that has hit zero, which means we're about to have another liquidity crisis. But if you zoom out on this chart back to the early 2000s, you can see in normal conditions, the reverse repo facility of the Fed is not tapped. It briefly for a few years was used quite extensively as an overflow for the excess liquidity in the financial system that happened from all the money printing in 2020. But because of the Fed's QT over the last couple of years, all that liquidity has been drained from the system and we no longer have excess liquidity. But the removal of excess liquidity from the financial system doesn't mean that we are about to face a shortage of liquidity or a crisis there.
And in response to that, a lot of people show you this chart, which is the regular repo facility at the Fed, which is where banks and financial institutions go when they cannot get enough cash from each other. and they'll show you dates like October 31st and December 1st when financial institutions tap the Federal Reserve for emergency liquidity. They will point to that as a sign of a liquidity crisis or a financial crisis. Banks about to fail right around the corner. But the problem is what they're showing you is the fact that we don't actually have a crisis right around the corner here because if you look at this chart, they're getting the liquidity they need from the Fed themselves. This is something that the Fed established during 2020. Their standing repo facility so that we wouldn't have any sort of an acute liquidity crisis where banks would be at risk of toppling over just because they can't access the overnight funds that they need from each other. So now any amount that banks need overnight, they can just get that from the Fed. And when you have an unlimited liquidity source that you can tap at any moment, you're not going to run into a liquidity crisis that's going to knock banks over. So that is not the reason the Fed has ended QT either.
And the reason we know this is because the way the Fed has ended QT is actually a mix of continuing QT in some areas and actually starting up QE again in other areas. If we look at the Federal Reserve's implementation notes from their last FOMC meeting, we can see they announced their plan to end quantitative tightening here where they said that on December 1st, they would just roll over at auction all principal payments from the Federal Reserve's holdings of Treasury Securities, which means anything that the government pays back to the Fed when that debt matures and the government has to pay that debt back, any of that that's held at the Fed, as that money gets paid back, the Fed says, "We're just going to take all that cash, just go right back out and purchase another Treasury security. We're just rolling it right back over." And so the amount that the US government owes to the Fed would remain the same.
This makes borrowing for the government a little bit easier than it's been previously because previously when the government would pay back what it owed to the Federal Reserve, they wouldn't be able to get all of that as new borrowing from the Federal Reserve. They would have to go find a new borrower instead because some of that the Fed would not be rolling over. It'd be like if you had a treasury and it was a 10-year Treasury and finally your 10 years was up. Government pays you back and they said, "Hey, would you like to reinvest and buy another 10-year bond?" And you would say, "Uh, no, not really. Uh, I just want to keep the money this time." The government's going to go have to find somebody else to borrow from because they're not running a surplus. They are borrowing everything they need to pay back everything that matures, plus more to pay all of their bills for the deficit that they're spending. So, for the last couple years, all that money they paid back to the Fed, they've had to find new borrowers to replace the Fed. Starting on December 1st, that is no longer happening. It's making government borrowing a little bit easier.
But remember how I just said the way the Fed is ending QT is continuing QT in some areas and actually starting QE in other areas. We have to take a look at this next note from the implementation notes from their last meeting where they said beginning on December 1st they will reinvest all principal payments from the Fed's holdings of agency securities into Treasury bills because remember the Federal Reserve holds two types of assets. They hold Treasury securities, which is debt that the government owes to the Fed. But they also hold a bunch of mortgage back securities, which means there's a very good chance when you're paying your mortgage or if you pay it off early, that money is making its way to the Federal Reserve. And for the last couple of years, the Federal Reserve has also been selling those off and letting those roll off their balance sheet. As of December 1st, they will still be doing that. their holdings of mortgage back securities will continue to decline. And when they get paid back, they will take that cash and put it instead into treasury bills, which means they will continue sucking liquidity out of the mortgage market and instead they're just injecting it into the broader economy by loaning it to the US government and making the US government's borrowing easier.
So, this is continued QT specifically for mortgage back securities and increased easing that'll have a broader effect everywhere else. It'll keep short-term interest rates down and it'll make government borrowing easier and cheaper. So, the effect of this is actually QE for treasuries and QT for mortgages. In this way, the Fed can keep their balance sheet steady. Which means for the average person, if they do look into this and they figure out, oh, I can look at the Fed's balance sheet and they go look and see it's just moving sideways, they'll be like, well, the Fed's not injecting liquidity. And technically, overall, that will be true. But what's happening behind the scenes is they're sucking more money out of mortgages and handing it to the US government instead. So QT for mortgages, QE for the government.
Now, the next couple of things you're going to see happen over the coming months and quarters. Show us what the true reason is for the Fed ending QT here. The first thing that you should expect over the coming months and quarters is a drop in short-term interest rates. As of the time of this recording, the odds of an interest rate cut at the Fed's next meeting is 87%. And this will continue throughout 2026. And the primary reason for this is not the incoming economic data. The primary reason for this is leadership change at the Fed. Powell's term is up in 2026. Ever since Trump got elected, there has been massive pressure he's been putting on Powell to lower rates. And the leadership overall at the Fed has started to change as well.
Specifically, one of the new governors of the Federal Reserve just wrote a paper and gave a speech on the regulatory dominance of the Federal Reserve's balance sheet. I made an entire video about this, but just to summarize, the entire speech was dedicated to showing why the Federal Reserve needs to deregulate the banks. And the subtext reading between the lines is because it will let the banks do quantitative easing for the Fed. Given what happened in 2020 and 2021 and all the inflation that that unleashed, it would be extremely politically unpopular for the Fed to just actually restart QE again, for the bet Fed's balance sheet to start rising. Everybody would be looking at that and saying, "Hey, we don't like this and we don't want this." And so instead, what they are likely to do through the leadership changes that are going to happen at the Fed over the coming months and quarters is allow the banks to buy an unlimited number of treasuries. Right now, banks are limited in how many treasuries they can buy. In other words, how much money they can loan to the US government by their risk ratios. It's called the supplementary leverage ratio. But given the fact, like we discussed earlier, banks can always tap the Fed for any liquidity that they need, even if the treasuries they own are at a loss, there's another facility that the Fed has used before that allows banks to temporarily sell treasuries to the Fed at full price, which means that treasuries are now functionally fungeable with reserves. And if that sentence sounds like Greek, I know it was stupid. Basically, what it means is that if the banks hold treasuries, they don't have to worry about losses. There are multiple ways that the Fed has laid out that banks don't have to deal with realized losses on treasuries, which means that to a bank, it operates like reserves for them. And so the argument is they shouldn't be limited in how many treasuries they can buy, which makes sense, but it also means that banks can do QE for the Fed, which means banks can loan an unlimited number of dollars to the government and the Fed doesn't have to do it themselves.
And the reason why this is necessary is because while the Fed is lowering short-term rates, long-term rates are actually going up. This is a chart of the 10-year yield on the US government Treasury bond going back to 2020. And you can see for a while the 10-year Treasury yield was extremely low. And obviously when the Fed started hiking rates as a result of all the inflation they unleashed, the 10-year yield also skyrocketed. But the bottoms in yield have continued to rise just like the highs in the 10-year yield have continued to fall. Compare that with short-term interest rates, which have only fallen as the Fed has been cutting. In other words, as the Fed cuts, the yield curve is steepening. And that is a direct result of the market pricing in higher future expectations of inflation. Just think about it. If the government has the ability to borrow more and spend more easily and the money they're borrowing and spending is being printed into existence, that is a rising pressure on prices. If you as a lender knows that prices will be higher in the future, you will demand a higher interest rate on your loan to compensate you for the loss of purchasing power along the way. Which means the more downward pressure we get on rates at the short end for things like T bills and the Fed funds rate, the higher those longer-term rates are going to go. But the entire push for this, especially by the government, is to get their borrowing rates lower, not higher. But it's having the opposite effect. And the only way you can fix this is with quantitative easing, which we've already discussed would be very unpopular for the Fed to outright do, which is why they're doing it through a twist on their balance sheet. They're selling mortgage back securities, using that to roll over to T bills. So, they have to do it secretly behind the scenes. They can't do it outright. Or they could do yield curve control, which again would be quantitative easing because yield curve control, they have to add bonds to their balance sheet. And so, they're pushing the banks or they're going to allow the banks to do it instead through deregulation. And this is the real reason behind why we're seeing QT end now, why we're seeing rates lowered into the future, and why we're seeing the push to deregulate the banks. It is because the government needs it. They need an ever-expanding base of newly created money to borrow into existence so that they can spend and afford to do so. If nothing changed from here and everything stayed the same in terms of the Fed's balance sheet, the bank's balance sheets, interest rates, that would eventually push the government over into default. There's not enough money for them to continue spending the way they are. They need an ever-expanding money supply to continue to tap. And that is the true reason behind what's going on right now.
And you can see this directly by looking at the Federal Reserve Reform Act of 1977. I always say that it's Congress that controls the Fed, not the other way around. And everybody loses their minds because they love the conspiracy and love the fact that the Fed started as an independent private institution. But anything only exists as long as the monopoly on violence wants it to exist. And the only way the monopoly on violence wants it to continue to exist is if it serves their purposes. The fact of the matter is the Federal Reserve could be shut down tomorrow if Congress actually wanted it. But instead, they gave them a triple mandate, one job through three roles to force them to only do things that serves the government. We can see in section 2A on the first page, it says, "The board of governors of the Federal Reserve system and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production." The thing the Federal Reserve must do is expand the money supply. That's what monetary and credit aggregates means. Expand the money supply along with the growth in the economy. That's what commensurate with the economy's long-run potential to increase production means. If the economy grows, expand the money supply along with it so that any increase in wealth does not show up in cost of living going down for individuals like it did for all of human history. Instead, that increase in productive capacity will be soaked up by the government through a debasement of the currency, through loss of purchasing power. If the pizza grows, cut more slices into it so that each slice never actually has more pizza. And where do all those extra slices go? You guessed it, to the government's ever-expanding appetite for borrowing and taxing. And we know that because it says in the amendment, the way to achieve that is with maximum employment, stable prices, and moderate long-term interest rates.
What does maximum employment actually mean? It means the maximum total tax base. The more people who have jobs and the longer they must have jobs means the more the government can tax people. So maximum employment is not about wealth. It's not about individuals getting a better life. Maximum employment is about maximizing the tax base. The second mandate, stable prices. Left alone, prices go down. When you measure the real cost in terms of hourly work that a human has to do in order to achieve basic necessities or even luxuries throughout all of human history, it gets cheaper. We need much less human labor to get food, shelter, clothing, transportation, and entertainment than we did even 50 years ago, 100 years ago, 5,000 years ago. Prices in real terms go down as we discover new ways to make things more efficiently. That's what growth is. It's getting more for less. But if you can make sure that you print money enough to make sure prices don't ever go down, then number one, you increase your tax base because everybody's incomes keep on going up. It's no accident that the Federal Reserve was established the same year as the individual income tax. If prices continue to go up, wages continue to go up, you get to tax everybody more and more and more and more. But it's also to decrease the debt load. Because we know that inflation helps the borrower and hurts the lender because as the value of those dollars goes down, you get to pay back dollars that were easier to get than the dollars you originally borrowed and spent. In other words, you borrow something of higher value, pay something back of lesser value. So the stable prices mandate allows the government to maximize their tax base and decrease their real debt load. And third mandate of moderate long-term interest rates is very self-explanatory. Make sure long-term interest rates never get too high because that's what the government relies on to borrow. And that again is everything that we're talking about today. Why quantitative tightening is ending. Why quantitative tightening for mortgages is continuing and quantitative easing for tea bills is starting and bay regulation is being talked about. Short-term interest rate cuts are on the horizon and happening. All in order to make sure the long-term interest rates stay moderate, which is up to interpretation. And the interpretation is always that the government continues to borrow and spend whatever they want. And that is the reason why we're seeing everything we are seeing right now.
Which means if you are bearish on asset prices because you expect deflation, you expect defaults. It is very likely in my opinion we are headed in the exact opposite direction. As more money enters the system that pushes prices up. As more money enters the system and borrowing gets easier that pushes defaults and delinquencies down. More people have more money to spend regardless of what that does to quality of life when you measure it in real terms. But that's just the opinion of one guy on the internet. But take it for what it's worth. If you want more stuff like this, especially stuff that I do not talk about on YouTube, I have a free newsletter. It is not just a rehash of the videos that I make. So if you'd like to see me in your inbox every week, go ahead and click on that link in the description and sign up for free. As always, thank you so much for watching. Howy deck.