Quantitative tightening (QT) is the process by which a central bank shrinks its balance sheet, reversing the bond purchases made under quantitative easing. Instead of buying government bonds and mortgage securities, the central bank lets them mature without reinvesting the proceeds, or in some cases sells them outright. The effect is to drain reserves from the banking system and return duration risk to private investors.
How QT works in practice
When a bond on the central bank’s balance sheet matures, the government repays it, and the central bank simply extinguishes the money rather than recycling it into new purchases. Commercial bank reserves fall by the same amount. Most central banks run QT passively with monthly caps on how much is allowed to roll off, precisely because the mechanism is powerful and poorly understood even by its operators.
Why it matters for markets
QT works through two channels. It increases the supply of bonds private buyers must absorb, which, all else equal, pushes yields higher, particularly at longer maturities. And it drains the reserves that underpin money markets: run QT too far and overnight funding rates spike, as happened in the US repo market in September 2019, the episode that forced the Federal Reserve to halt its first QT programme. The binding constraint on QT is rarely inflation; it is money-market plumbing.
What to watch
The level of bank reserves relative to what the system needs (central banks estimate this poorly until they hit it), usage of the Fed’s reverse repo facility as a buffer that absorbs QT before reserves do, repo rates trading above the policy corridor, and Treasury issuance schedules that add supply on top of roll-off. When central bankers begin discussing ample reserves in speeches, the end of QT is being negotiated in public.