M IdeaCorrection: Global Economics and Macro Strategy | North America Earlier Start, Slower TaperMorgan Stanley & Co. LLCSeth B CarpenterChief Global Economist Seth.Carpenter@morganstanley.com +1 212 761-0370 Efrain A Tejeda, CFAStrategist Efrain.Tejeda@morganstanley.com +1 212 761-3529 Ellen ZentnerChief US Economist Ellen.Zentner@morganstanley.com +1 212 296-4882 Guneet Dhingra, CFAStrategist Guneet.Dhingra@morganstanley.com +1 212 761-1445 Jay BacowStrategist Jay.Bacow@morganstanley.com +1 212 761-2647 Martin W Tobias, CFAStrategist Martin.Tobias@morganstanley.com +1 212 761-6076 Matthew HornbachStrategist Matthew.Hornbach@morganstanley.com +1 212 761-1837 Vishwas PatkarStrategist Vishwas.Patkar@morganstanley.com +1 212 761-8041 We have removed FX trades from the valuation methodology and risks section, which were included in error. This note was originally published on January 19, 2024, and is being republished on January 19, 2024. Pricing data and disclosures reflect original publication date. To receive an electronic copy of the original version of this publication, please send an e-mail to Equity_Research_Publishing@morganstanley.com with the publication title and date. Fed communication has put QT in the spotlight. We look for Fed discussions at upcoming meetings resulting in a June start to taper, earlier than our previous expectation. But the market narrative that the end of QT is coming soon has been overdone. Earlier start will be paired with a slower taper. Key Takeaways• The Fed will start discussing tapering QT soon, but will not end QT soon. Recent Fed communication has stirred market discussion about the end of QT. That narrative is overdone. We see the Fed discussing QT at upcoming meetings, likely announcing the parameters of a taper to QT in May and initiating the taper in June. • Our baseline is the Fed cuts the pace of QT in half for Treasuries to $30bn/month, but leaves MBS to run off with prepayments. If we're wrong, it is more likely the taper pace will be slower, not faster.• We discuss mechanics of our projections, but we expect the SOMA portfolio to fall about $750bn from the current level. We see the RRP facility falling to roughly $0, and QT ending in early 2025 when reserves are about $3.2tn. • Enormous uncertainty surrounds the ultimate size of the balance sheet and the end of QT. The Fed has clearly said it will monitor market conditions to determine when to stop. Two key parameters stand out among many it will monitor. If the SOFR-IORB spread goes to zero or turns positive, it will be important. If the standing repo facility (SRF) is used in size, it will also be a meaningful signal. • Although markets will pay close attention to the Fed's balance sheet, we see the implications for fixed income markets as limited. The shift in supply of Treasuries relative to expectations will likely not be substantial...
