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Fed Announces Significant Curtailment of Quantitative Tightening Program, Sending Treasury Yields Lower






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Wednesday’s Federal Reserve Policy Decision

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Introduction

Wednesday’s Federal Reserve policy decision was fairly boring for investors. Officials kept interest rates the same, just as they have since July 2023.

Quantitative Tightening Program Update

But some savvy traders are excited about another key decision. The Fed announced that it will significantly curtail its quantitative tightening (QT) program, the selling off of its assets to decrease money supply and increase interest rates, beginning in June.

Impact on Treasury Yields

US Treasury yields fell on the news. Yields on the 10-year and 2-year both dropped by 0.05 percentage points.

Background

The Fed bought a ton of government-backed bonds between 2020 and 2022 to help support economic recovery after the pandemic-induced recession. Those purchases ended up pushing down interest rates in certain parts of the economy, like housing and auto sales.

Current QT Program

The Fed currently lets up to $60 billion in Treasuries mature each month without replacing them, reducing the amount of money circulating in the economy. The idea is that QT can help exert some downward pressure on prices.

Concerns and Risks

But there’s also some downside to the practice. Changing the amount of liquidity in the economy and redirecting that money could have some major consequences.

As JPMorgan Chase CEO Jamie Dimon pointed out in his annual letter to shareholders last month, “we have never truly experienced the full effect of quantitative tightening on this scale.” The current pace of QT is draining more than $900 billion in liquidity from the system annually, he said, adding, “I am more worried [about it] than most.”

QT reduces the amount of money in the banking system, leading to higher interest rates and tighter monetary conditions, but last time the Fed implemented such a program in 2019, some banks fell very short of reserves. That led to a “repo crisis”, where the interest rates for overnight loans between banks spiked unusually high. The Fed had to intervene and provide liquidity to bring down those repo rates.

Fed’s Response and QT Plan Adjustment

Fed Chair Jerome Powell doesn’t want a repeat of 2019 and said at his last press conference that QT would be scaled back soon.

On Wednesday, officials announced that they will lower the rate of QT to $25 billion, more than half of where it currently sits.

Implications for the Bond Market

“May 1 is set to be a big day in the bond market,” Evercore ISI’s Krishna Guha and Marco Casiraghi wrote in a recent note.

If the Fed does ease up its tightening policy, “financial markets will likely see the taper of the QT program as bullish for riskier investments like stocks and bonds at the margin,” wrote Bill Adams, chief economist for Comerica Bank, in a note on Tuesday.

That’s because a taper should send bond prices higher, and interest rates lower.

The risk, wrote Bank of America analysts on Tuesday, “is skewed to the upside for stocks, in our view, especially given a potential QT taper announcement.”

Update on Marijuana Rescheduling

The Biden administration moved Tuesday to reclassify marijuana as a lower-risk substance, recognizing its medical benefits and carrying broad implications for cannabis-related research and the industry at large.

DOJ’s Recommendation and Formal Process

The US Department of Justice recommended that marijuana be rescheduled as a Schedule III controlled substance, a classification shared by prescription drugs such as ketamine and Tylenol with codeine.

“Today, [Attorney General Merrick Garland] circulated a proposal to reclassify marijuana from Schedule I to Schedule III,” Xochitl Hinojosa, the DOJ’s director of public affairs, said in a statement. “Once published by the Federal Register, it will initiate a formal rulemaking process as prescribed by Congress in the Controlled Substances Act.”

The formal rulemaking process is lengthy, typically includes a public comment period, and could take months to complete.

Political and Public Reactions

The rescheduling recommendation was hailed by lawmakers on both sides of the aisle as a step closer to ending the failed war on drugs.

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Founder of Leading Crypto Exchange Sentenced

Changpeng Zhao, the founder of the world’s leading cryptocurrency exchange, was sentenced on Tuesday to four months in prison after pleading guilty to money-laundering charges last year.

The sentence, handed down in a US federal court in Seattle, is far lighter than the three years prosecutors had argued for.

Apology and Consequences for Binance

Prior to the sentencing hearing Tuesday, Zhao, who goes by CZ, apologized for mistakes he made as CEO of Binance, the crypto exchange he founded in 2017.

“Words cannot explain how deeply I regret my choices that result in me being before the Court,” he said in a letter to the judge. “Rest assured that it will never happen again.”

Binance agreed to pay more than $4 billion in fines and other penalties as part of a coordinated settlement with the federal government last fall. The company admitted to engaging in anti-money laundering activities, unlicensed money transmitting, and sanctions violations.

Zhao, who is 47 and has a personal fortune of nearly $40 billion, according to Bloomberg, agreed to step down as CEO and pay $200 million in fines.


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