Don't just look at interest rate cuts! The Fed's "invisible point shaving" has begun, and a silent liquidity reversal is unfolding.

Written by: White55, Mars Finance

On October 29, the Federal Reserve announced a 25 basis point rate cut, lowering the target range for the federal funds rate to 3.75% to 4.00%, marking the fifth rate cut since September 2024. However, more intriguing than this decision, which aligns with market expectations, is another decision simultaneously announced by the Federal Reserve: the plan to end the reduction of its balance sheet starting December 1. This policy, referred to as quantitative tightening by the market, has reduced the Fed's balance sheet size from nearly $9 trillion at the peak during the pandemic to about $6.6 trillion since it was initiated in 2022. Its conclusion suggests that the global liquidity environment will undergo a significant transformation.

Policy Shift: From Implicit Extraction to Mild Injection

The essence of quantitative tightening is that the Federal Reserve quietly withdraws liquidity from the financial system by allowing maturing bonds not to be renewed. This policy began in June 2022 when the United States was facing the challenges of high inflation, and the Federal Reserve needed multiple tools to work together to tighten financial conditions. Over the past three years, QT and interest rate hikes have formed a synergy: increasing the price of funds while reducing their quantity. Since 2022, by allowing some bonds to mature without renewal, the Federal Reserve's balance sheet size has significantly reduced from its peak. However, the situation is changing. In mid-October 2025, Powell warned during a speech at a meeting in Philadelphia that there are signs of further cooling in the U.S. labor market. He also stated that as the liquidity conditions in the financial system are gradually tightening, the quantitative tightening plan may be nearing its end. The Federal Reserve has agreed to adopt a “very cautious” approach to avoid the type of pressure experienced in the money market in September 2019. Ending QT means that the Federal Reserve will stop withdrawing liquidity from the financial system and instead reinvest the proceeds from maturing securities, effectively re-injecting funds into the market. This shift appears to be a technical adjustment but actually has far-reaching effects on market liquidity.

Decision Logic: Preventive Measures and Market Stabilization

The decision by the Federal Reserve is based on a cautious assessment of the economic outlook and considerations for market stability. Powell's overall judgment conveyed in his October speech, that “employment concerns outweigh inflation risks,” has become a key basis for the shift in Federal Reserve policy. Although inflation remains above the Federal Reserve's 2% target, long-term inflation expectations still align with that target. Signs of cooling in the labor market are becoming more evident, and Powell noted that “in this less vibrant and somewhat weakened labor market, the downside risks to employment seem to be rising.” Federal Reserve policymakers acknowledge that the federal government “shutdown,” which has lasted nearly a month, has constrained their decision-making process. The lack of official data makes it difficult for the Federal Reserve to accurately assess the current economic situation, and this uncertainty has prompted the Federal Reserve to adopt a more cautious policy stance. The decision to end QT also reflects the Federal Reserve's concern about market liquidity. The New York Fed conducted large-scale repurchase operations in September to alleviate liquidity pressures in the money market. These operations suggest that bank system reserves may have fallen close to the minimum comfort level, and further balance sheet reduction could jeopardize market stability.

Market Impact: The Covert Transfer of Liquidity

The end of QT will have profound and complex effects on various assets. According to the analysis by Dong Zhongyun, chief economist at AVIC Securities, the end of balance sheet reduction may have three main impacts: first, market liquidity in the U.S. is expected to improve, avoiding a repeat of the 2019 repo market crisis; second, the end of balance sheet reduction means that the Federal Reserve stops reducing its bond holdings, thus alleviating the selling pressure in the bond market, which helps lower long-term yields; third, the end of balance sheet reduction can enhance expectations for monetary policy easing, creating a synergistic effect with interest rate cuts. Although the Federal Reserve announced a rate cut on October 29, long-term Treasury yields continued to rise. This seemingly counterintuitive phenomenon reveals a divergence in market expectations regarding future policy direction. Powell pointed out that there is a “serious divergence” among policymakers regarding actions in December, which adds uncertainty to future policy direction. However, the supportive effect of the end of QT on the stock market may be more direct. The end of QT means that the pressure of liquidity withdrawal from the market by the Federal Reserve is reduced, which will support U.S. stocks, especially growth stocks and technology stocks that are sensitive to liquidity, will receive more favorable conditions. This view coincides with that of Bill Adams, chief economist at the Dallas Federal Reserve Bank, who believes that the end of QT may “translate into more liquidity in financial markets and more private investment funds flowing into risk assets in the near future.” Subtle change: the “implicit interest rate cut” effect of the end of QT.

Some analysts believe that even if the Federal Reserve pauses interest rate cuts in December, ending QT early could produce effects similar to an interest rate cut. John Luke Tyner, a portfolio manager at Aptus Capital Advisors in Alabama, even suggests that ending QT before 2026 could provide investors with an effect equivalent to a 25 basis point rate cut. This effect of “implicit rate cuts” is primarily achieved through two channels: first, alleviating the fundamental pressure on bank reserves, and second, managing the supply and maturity structure of Treasury bond issuance. The end of QT means that the Federal Reserve will take some of the Treasury bond supply from the private market, altering the supply-demand balance in the market. However, not all analysts agree with this direct analogy. Derek Tang, an economist at Washington-based monetary policy analysis firm, believes that the end of QT amplifies any interest rate cut's effects by “strengthening equity market risk appetite,” but he views the Federal Reserve's move more as a “gradual adjustment” of balance sheet policy. The decision to end QT is also closely related to the U.S. Treasury's bond issuance strategy. FHN Financial macro strategist Will Compernolle points out that after the end of QT, the Treasury has greater flexibility in bolstering its general account cash balance, while the Federal Reserve will become a “willing buyer, absorbing some of the Treasury bond demand.”

Global Impact: The Spillover Effects of Dollar Liquidity

The Federal Reserve's shift in monetary policy has never been merely a domestic affair for the United States; its spillover effects will have profound impacts on global capital markets. Historical experience shows that tightening monetary policy by the Federal Reserve often accompanies financial crises in emerging markets or globally. However, the end of this round of QT may be beneficial for emerging markets. The Federal Reserve's cessation of quantitative tightening will alleviate the capital outflow pressure faced by emerging markets, helping to improve their external financing environment. As the pressure of dollar liquidity tightening eases, international capital may flow back into emerging markets in search of higher returns. The trend of the dollar index will also be affected. The narrowing of interest rate differentials between the U.S. and foreign countries due to interest rate cuts will further weaken the dollar's attractiveness, compounded by the “de-dollarization” sentiment catalyzed by global trade frictions, leading to greater pressure on the dollar index. This judgment aligns with the predictions of Franklin Templeton Investments, which expects inflation concerns to result in the Federal Reserve's rate cuts being lower than anticipated, with the final target range for this round of policy rates possibly being above 3.5%. The commodity market may exhibit a differentiated trend. Gold may benefit from falling real interest rates and renewed safe-haven demand, with its price likely to continue rising; oil prices, on the other hand, are still priced based on supply and demand fundamentals, with OPEC+ production cuts and Middle Eastern geopolitical risks remaining core variables determining the marginal direction of oil prices, and the impact of interest rate cuts is likely to be relatively limited. Future outlook: The fog of policy paths.

Despite QT coming to an end, the future policy path of the Federal Reserve remains full of uncertainty. Powell stated at the press conference following the October meeting that there are clear divisions among officials on how to act in December, and that another rate cut at the December meeting is not a foregone conclusion. The schedule published on the Federal Reserve's official website shows that there will be one more rate meeting in 2025, with the new rate decision to be announced on December 11 at Beijing time. This meeting will be more significant as it may provide more clues for the policy path in 2026. Major institutions have differing predictions on the future direction of the Federal Reserve's policy. Morgan Stanley predicts that the Federal Reserve will continue to cut rates until January 2026, with two additional cuts in April and July 2026, ultimately lowering the federal funds rate target range to between 3.00% and 3.25%. In contrast, a research report from CICC suggests that under 'natural circumstances', there is still room for three rate cuts in this round by the Federal Reserve, corresponding to long-term rates of 3.8-4.0%. The company also stated that while the Federal Reserve still has some room for easing, the pace of rate cuts may slow down, and overly optimistic expectations should be avoided. New uncertainties are also emerging. CICC pointed out that the new Federal Reserve Chair and the independence of the Federal Reserve are the biggest variables for the rate-cutting path next year, which could increase policy uncertainty after the second quarter of 2026. This viewpoint suggests that political factors may have a greater impact on the future direction of monetary policy.

The money market fund has set a record of $7.42 trillion in assets, reflecting the market's thirst for returns and its pursuit of safe assets. After QT ends, these dormant capital giants may readjust their layouts in search of new habitats. The Federal Reserve will terminate the QT program on December 1, but Powell has also made it clear that a rate cut at the December meeting is not a certainty. This cautious attitude itself is a mirror, reflecting the Federal Reserve's difficult balance between inflation and growth, data deficiencies, and policy foresight. The curtain of the liquidity feast has slowly been raised, but the duration of the feast and its ultimate outcome will still depend on the final direction of the economic fundamentals.