How the Fed’s balance sheet unwind is reshaping rate expectations – and where to deploy capital now
🔥 The Taper Blueprint: Decoding the Fed’s Liquidity Withdrawal
The Federal Reserve’s May 2025 policy shift marked a critical inflection point: QT redemption caps were slashed to 60B), while maintaining $35B for MBS. This “stealth tightening” achieves two objectives:
1️⃣ Mitigating liquidity crises by avoiding a repeat of the 2019 repo market freeze, where reserve scarcity triggered overnight lending rates to spike above 10%
2️⃣ Enabling longer QT duration** – Dallas Fed President Logan emphasized this slower pace allows deeper reserve drainage over time, potentially extending into 2026 before balance sheet normalization
Jerome Powell’s press conference reinforced this strategy: “We want this process to continue. Its current measured pace is intentional – it needs to persist longer.” The move signals confidence in banking resilience despite commercial real estate (CRE) exposures at regional banks
📉 Inflation’s Grip: Why Rate Cuts Remain Delayed
March’s core PCE shock at 2.8% YoY (vs. 2.6% expected) cemented the Fed’s hawkish hold. Our FedWatch PRO tool tracks three structural barriers to near-term easing:
- Sticky services inflation: Wage-sensitive categories (shelter, healthcare) rose 0.4% MoM in Q1, outpacing goods disinflation
- Fiscal dominance risks: Powell’s blunt warning that “federal debt is on an unsustainable path” limits stimulus options, with Treasury issuance crowding out private credit
- Geopolitical tariff spillover: Trump’s 60% China tariffs could add 0.7% to CPI by Q4 if implemented – a scenario priced at 78% probability in our policy conflict module
Critical FedWatch PRO Alert: September cut odds plunged from 65% to 52% after June payrolls beat estimates. The tool now shows zero full cuts priced for 2025 – only 38bps of easing by December.
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