The impact of quantitative tightening (QT) is being felt the world over, with banks across virtually every continent utilizing the strategy to introduce calm to choppy markets. 

Acting as a hangover from the COVID-19 pandemic, the Federal Reserve was a leading example of how banks used quantitative easing (QE) to reduce the economic impact of lost industry and short-term market crashes by purchasing significant quantities of US Treasury bonds and mortgage-backed securities (MBS), as well as lowering interest rates to almost zero. 

The result of the approach was an inflated balance sheet that rallied from around $4 trillion prior to the pandemic to almost $9 trillion by 2022. 

While QE expands balance sheets, QT shrinks it, and as the mass uncertainty caused by the pandemic subsided, the Fed embarked on a period of quantitative tightening. But how can we define QT? And what market impact does this rejigging of balance sheets cause? Let’s take a deeper look at the effect quantitative tightening has on Wall Street and other global financial markets: 

What is Quantitative Tightening? 

Quantitative easing has been in the public lexicon for some time and rose to prominence as banks sought to mitigate the impact of the 2008 financial crisis. However, quantitative tightening is a lesser-known process that creeps into play when it’s time to lower balance sheets and sell assets. 

Also known as balance sheet normalization, QT is a monetary policy strategy that’s sometimes followed by central banks. In a nutshell, quantitative tightening happens when a central bank like the Federal Reserve slows the pace of its reinvestments from government bond proceeds to reduce its balance sheets. 

Quantitative tightening often appears alongside interest rate increases as a means of curbing the money supply in economies. 

Additionally, a central bank can create a schedule for slowing the reinvestment process that’s to be followed until balance sheet normalization occurs. The definition of normalized balance sheets is controlled by the central bank, but the ultimate goal of QT isn’t to unwind all money lent to the government during the easing process but to manage the flow of currency throughout the economy to ensure a healthy rate of growth. 

The State of QT in 2025

Quantitative tightening measures have been dispatched by central banks worldwide, and 2022 saw the Bank of England (BoE), Reserve Bank of New Zealand (RBNZ), Sveriges Riksbank (Riksbank), Bank of Canada (BoC), Reserve Bank of Australia (RBA), Federal Reserve (the Fed) and the European Central Bank (ECB) all undergo QT in a bid to calm domestic inflation. 

The measures had proved to be successful, with all seven banks making meaningful progress in reducing their balance sheets. But as markets have cooled based on inflation figures, are we set to see a slowing of QT in 2025? 

Since May 2022, the US Federal Reserve has lowered its balance sheet by nearly $2 trillion, but what is the end goal of quantitative tightening? 

Liquidity is an important topic for the economy as well as Wall Street, and market participants will be wary of a liquidity scare should the Fed’s balance sheet fall further. 

As the Fed underwent QE during the pandemic, the central bank boosted its reserves by $2 trillion, and the reverse repo facility (RRP) by $2.3 trillion. When the Fed switched from easing to tightening, it targeted declines in RRP to lower its balance sheet.  

The Federal Reserve is eager to maintain much of its reserves to deliver market stability and the arrival of Donald Trump ahead of his second term in office could deliver much market uncertainty throughout 2025. With this in mind, we could see QT come to an end sooner rather than later. However, its market impact could shape institutional investing in the coming years. 

How QT Impacts Wall Street

In 2019, UBS analyzed the impact of quantitative tightening on the investment landscape and found that the Federal Reserve typically takes a more controlled approach to its tightening process than quantitative easing. This is because QE is generally a response to an adverse market scenario like a crash while QT is more of a post-easing stability strategy. 

The analysis also found that quantitative tightening would have a less heavy impact on liquidity or inflation due the the lack of a mismatch in the supply and demand for cash. 

Unlike in the 2008 financial crisis when liquidity preference rose and QE was the Fed’s response, falling liquidity preference means that the Fed can effectively lower its cash reserves without a jarring market impact. 

While these weaker market implications are similar for other global central banks implementing a QT strategy, it’s certainly worth hedge funds adopting prime services like 26 Degrees Global Markets and other brokers that offer international market exposure to look beyond any liquidity constraints in 2025. 

UBS analysis found that quantitative tightening in 2019 was a necessary measure because if the Fed wasn’t reducing liquidity supply, it would become mismatched with demand, which would lead to complications surrounding inflation. 

What’s Next for QT and Wall Street?

As the US seeks to turn a corner on lingering stubborn inflation, 2025 is likely to be a crossroads year for the Federal Reserve’s quantitative tightening outlook. 

With the unpredictability of Donald Trump arriving in the White House and his bold ambitions towards the economy, it makes sense for the Fed to look at maintaining a healthy balance sheet as the uneven impact of trade tariffs influences market performance. 

For investors, the prospect of the end of QT could present new opportunities for investing in growth. However, adopting a more globalized outlook could be the best hedge against the unpredictability of the US economy and possible further tightening measures looking to the new year.