Andy Constan CEO of Damped Spring was my guest this week.
Andy’s career has been a long one, with stints at Bridgewater and Brevan-Howard. Andy is a master of the monetary system and its impact on economy and market.
The FOMC minutes, as I mentioned in my article last week shed some light on what the Fed wants to happen and the future balance sheet of the Fed. Andy was able to help me understand the nuance of this complex issue.
What can we learn from this discussion?
1. QT 2.0
It is planning what it will look like when QT has finished. The Fed seems to have a consensus on the need to try to match up the Treasury debt’s WAM to the Fed balance sheet’s weighted-average maturity.
The Fed balance sheet is currently at about eight years, while the Treasury’s has five. Andy did some complex math, but the main takeaway was that QT isn’t as finished as you might think.
Andy told me why it was so important.
“Well, let’s just say there was a crisis. In a crisis, bonds rally a lot on the front. Then, say [the Fed] decides to begin QE and let’s assume interest rates are zero as it has said pretty clearly they’re not going to do more QE until interest rates are zero. We’re back in a position where the Fed is buying one and a half percent coupons which — unless the crisis never resolves, it’s going to be underwater on those things and so it would be better, if you’re going to be underwater in those things, you’d rather not have a lot of them going into it.”
2. Debt ceiling dynamics
Due to its associated TGA pulldown, the ongoing debt ceiling has an impact on funding market. The FOMC Minutes hinted that QT could be paused to avoid volatility caused by the debt-ceiling drama.
Andy’s explanation:
“QT has two aspects: forcing the private sector to take on riskier assets and draining reserves from the financial system. The first didn’t happen as the Fed used runoff and Treasury muted it with bills. The second — reserve drainage — has been the primary driver of QT’s impact.
Pre-QT, the reverse repo (RRP) grew to over $2 trillion, acting similarly to bank reserves. While RRPs provide liquidity, money market funds don’t lend like banks do. Historically, removing reserves tightened lending due to fractional reserve requirements. But today, reserves aren’t necessary for lending.
QT has drained RRPs without yet affecting bank reserves. The key question is whether reserves remain adequate. Treasury spending during a debt ceiling standoff injects reserves, but once resolved, rapid TGA replenishment could drain reserves too fast, risking financial stress.
This volatility is why some suggest pausing QT, though it’s not a consensus view. If debt ceiling issues resolve, QT may continue unchanged. The Fed sees reserves as still abundant, and I estimate it could withdraw another $250-$500 billion, potentially extending QT into 2026. However, my view remains that it’ll stop at ~$3 trillion in reserves.”
3. Bessent Treasury Issue
I have written about the Treasury’s first QRA Meeting, which gave us a glimpse into the way Scott Bessent views Treasury issuance, compared to Janet Yellen, his predecessor.
In reality, he left things the same. It shocked many. Andy explained to me that the real proportion of bills issued could change due to changes in the size fiscal deficit.
“If they keep coupons the same and the deficit rises…well, they have to make it up with bills and so there’s more bills and the same amount of coupons that’s oversupplying the bills market and undersupplying the coupon market. And so if you’re going to keep it constant, the deficit will determine whether you’re going to be extending the debt. Meaning, if the deficit falls and you keep it constant, you extend the duration you’re terming out the debt. If the deficit rises and you keep coupons constant, you’re relying more on bills.”
It was my favourite interview this year. Go check out the full interview and don’t forget your notepad — this one’s a Macro 301 interview.
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