What is Quantitative Tightening (QT)?

Understanding Quantitative Tightening (QT)

Quantitative tightening (QT) is the process by which a central bank reduces the size of its balance sheet—typically after years of asset purchases under quantitative easing. The bank either lets bonds mature without reinvesting the proceeds or actively sells securities back to the market. Both methods withdraw liquidity, nudging interest rates higher.

How QT Works

• Runoff: Bonds mature and principal payments flow from the Treasury to the central bank, effectively destroying reserves.
• Active sales: Less common, but can accelerate balance-sheet shrinkage when policymakers want a quicker tightening effect.
• Runoff caps: Central banks often set monthly limits to avoid overwhelming markets with supply.

Market Impact

QT tightens financial conditions by increasing the supply of government bonds held by private investors, pushing yields higher and flattening the yield curve. In forex, currencies of central banks executing QT can appreciate if investors believe policy will remain restrictive. However, aggressive QT may spook risk sentiment, sending capital into classic safe havens regardless of which country is tightening.

Risks to Monitor

Rapid liquidity withdrawal can stress money markets, as seen during the 2019 U.S. repo spike. Funding strains or widening swap spreads may force policymakers to pause or slow QT. Additionally, if economic data deteriorates, markets may price in an earlier return to QE, causing sharp currency reversals.