The Fed ended its balance-sheet runoff in December 2025 and began reserve management purchases. Learn how quantitative tightening works, why it differs from QE, and its non-linear effects on bond yields and the US dollar.
From Balance-Sheet Normalisation to Reserve Management
Balance-sheet runoff is the policy process by which a central bank reduces the scale of the securities held on its balance sheet, commonly known as quantitative tightening, orQT. Its main methods of operation include ceasing to fully reinvest maturing securities, setting a monthly cap on principal redemptions, and, where necessary, actively selling assets. The Federal Reserve began this round of balance-sheet reduction in June 2022, primarily using a passive runoff approach of not rolling over maturing securities, rather than continuously selling US Treasuries into the market in a concentrated manner.
As of July 2026, any discussion of the Fed's balance-sheet runoff must first update one key fact: this round of reduction in securities holdings has already ended. The Federal Open Market Committee, orFOMC, decided on 29 October 2025 to halt the reduction in securities holdings from 1 December 2025. Since then, the Fed no longer lets US Treasuries mature and run off under the previous caps, and reinvests the principal payments from agency debt and agency mortgage-backed securities into short-term US Treasuries.
In December 2025, the Fed further launched reserve management purchases, used to meet the trend growth in liability items such as currency in circulation, Treasury deposits and bank reserves. This operation expands or maintains the size of the balance sheet, but its policy purpose is primarily to keep reserves in the banking system ample and to maintain control over short-term interest rates; it is not equivalent to quantitative easing, whose main goals are to lower long-term financing costs and stimulate aggregate demand.
The Fed's H.4.1 statistical release published on 16 July 2026 shows that, as of 15 July 2026, its total assets were around USD 6.743 trillion and the reserve balances of depository institutions were around USD 3.100 trillion. The FOMC statement of 17 June 2026 also confirmed that the target range for the federal funds rate was maintained at 3.50% to 3.75%, and that the policy framework for maintaining ample reserves in the banking system continued to be implemented.
Balance-Sheet Runoff Is Not Simply a Reduction in the Money Supply
The asset side and the liability side of a central bank's balance sheet must remain in balance. When securities mature and run off, the change on the liability side may show up as a fall in bank reserves, a fall in the overnight reverse repo balance, or a change in the Treasury General Account, with the specific outcome depending on the holders of the securities, fiscal revenue and expenditure, and the source of settlement funds. A reduction in the scale of assets therefore does not mean that the deposits held by households and businesses will fall in step by the same amount.
A central bank's balance sheet can be summarised using the following relationship:
Central bank assets = Bank reserves + Currency in circulation + Treasury deposits + Other liabilities and capital
When reserves are relatively ample, the immediate impact of runoff on short-term interest rates may be fairly limited; when reserves approach the banking system's demand range, repo rates, the federal funds rate and other money-market rates become more sensitive to changes in liquidity. To judge whether runoff constitutes substantive tightening, therefore, one cannot look only at the scale of total assets, but must also analyse reserves, overnight reverse repos and Treasury deposits at the same time.
| Policy tool | Main operation | Direct object of action | Common market implication |
|---|---|---|---|
| Quantitative tightening | Reducing the reinvestment of maturing securities, or selling securities held by the central bank | The scale of securities holdings, bank reserves and the supply of duration to the market | May raise the term premium, tighten liquidity and increase volatility in the bond market |
| Rate hikes | Raising the policy rate target or the rate paid on reserves | The short-term risk-free rate, financing costs and interest-rate expectations | Short-end yields usually respond more directly, and the interest-rate differential affecting exchange rates may change |
| Quantitative easing | Large-scale purchases of Treasuries, agency debt or mortgage-backed securities | The supply of long-term assets, the term premium and financial conditions | Usually used to lower long-term financing costs and support credit and economic activity |
| Reserve management purchases | Purchasing short-term Treasuries according to reserve demand and reinvesting principal | The supply of reserves, the short-term money market and the structure of the balance sheet | Mainly used to maintain interest-rate control; does not necessarily represent a policy shift to across-the-board easing |
(Source: Federal Reserve, Monetary Policy Report, published: 2026-07-10, Box 3 and Table A; Federal Reserve, Factors Affecting Reserve Balances, published: 2026-07-16, Table 5; Federal Reserve, FOMC Statement, published: 2026-06-17)
How the Bond Market Absorbs the Change in Supply Brought About by Runoff
The core of how runoff affects the bond market is not that the central bank puts all maturing bonds back onto the market, but that the central bank no longer uses principal payments to buy an equivalent amount of securities. Private investors need to absorb more net supply and bear more interest-rate risk and duration risk. If the Treasury simultaneously maintains a high scale of debt issuance, the total volume of Treasuries the market needs to allocate to increases further, and investors may demand higher yields as compensation.
Long-Term Yields Are Jointly Determined by Two Components
The yield on long-term US Treasuries is not determined by the current policy rate alone, and can be decomposed using the following framework:
Long-term Treasury yield = Expected future short-term rates + Term premium
Here, expectations for future short-term rates reflect the market's assessment of inflation, economic growth and the Fed's policy path; the term premium is the risk compensation investors require for holding long-term fixed-rate bonds. By reducing the central bank's stable demand for long-term securities, runoff may in theory raise the duration risk borne by the private sector, thereby placing upward pressure on the term premium.
However, runoff does not guarantee that long-term yields will keep rising. If expectations for economic growth fall markedly during runoff and the market expects the Fed to cut rates sooner, expectations for future short-term rates may fall and offset the effect of a rising term premium. Conversely, even once runoff has ended, a widening fiscal deficit, increased Treasury supply or rising inflation risk may still push long-term yields higher.
The Yield Curve May Flatten, or It May Steepen
Equating runoff directly with a flattening of the yield curve is inaccurate. The shape of the yield curve depends on the relative changes in short-end rates, long-term rates and the term premium:
The short end rises faster: when expectations of rate hikes dominate, short-term Treasury yields may rise faster than long-term yields, and the yield curve flattens or inverts.
The long end rises faster: when Treasury supply, the term premium or fiscal risk becomes the market's focus, long-term yields may rise faster, and the yield curve steepens.
Both the long and short ends fall together: when the risk of recession rises and the market turns to expectations of rate cuts, the entire yield curve may shift downwards even while the balance sheet is still shrinking.
Bank Reserves and the Repo Market Determine the Degree of Tightening
In the early stages of runoff, the banking system usually still holds a large volume of reserves, and the balance-sheet reduction can first be absorbed by overnight reverse repo funds flowing back into the banking system. As the overnight reverse repo balance approaches a low level, further runoff is more likely to reduce bank reserves directly. Once reserves approach the demand range, the Secured Overnight Financing Rate, the repo rate and the federal funds rate may become more sensitive to quarter-ends, tax periods and Treasury settlements.
In the second half of 2025, the Fed observed that reserves were gradually approaching an ample level, and launched reserve management purchases after ending runoff in December 2025. This policy switch shows that the end point of runoff is not the balance sheet returning to its pre-financial-crisis size, but reserves falling to a range that can maintain interest-rate control while avoiding sustained pressure in the money market.
Mortgage-Backed Securities May Still Decline Naturally
After the Fed halted overall runoff, the principal payments from agency mortgage-backed securities, orMBS, are reinvested in short-term US Treasuries rather than used to repurchase similar MBS. The Fed's asset structure may therefore still change, with MBS falling and US Treasuries rising. This process affects mortgage spreads, prepayment risk and housing-finance conditions, but should not be simply understood as a continued shrinking of total assets.
(Source: Federal Reserve, A User's Guide to Reducing the Federal Reserve's Balance Sheet, FEDS 2026-019, Sections 2 to 4; Federal Reserve, Federal Reserve Balance Sheet Developments, published: 2026-05-28, Box 1)
Why the Impact of Runoff on the US Dollar Exchange Rate Is Not One-Directional
Runoff is usually classified as a tightening policy, but whether the US dollar appreciates depends primarily on the relative financial conditions between the United States and other economies, rather than on the absolute change in the size of the Fed's assets. The foreign exchange market is highly forward-looking, and trading prices often already reflect the market's expectations of the pace of runoff, the interest-rate path and the economic outlook before a policy is formally implemented.
The Interest-Rate Differential Is an Important Variable in Pricing the Dollar
Rate hikes mainly change short-term interest rates and financing costs, while runoff works more through the term premium, liquidity and risk appetite. If the Fed maintains a high policy rate while conducting runoff, and Europe, Japan or other economies implement looser policy, the relative yield on US dollar assets may rise, thereby supporting the dollar's exchange rate.
If other central banks tighten policy in step, or the market expects the Fed to cut rates sooner than other central banks, the expected interest-rate differential between the United States and other economies may narrow. In this case, even while the Fed is still conducting runoff, the dollar may lack a basis for sustained appreciation.
When analysing the relative attractiveness of the dollar, the following simplified framework can be used:
Relative attractiveness of the dollar = US expected interest rate − Other economies' expected interest rate + Change in risk premium
This framework is not a precise exchange-rate pricing formula, but it can illustrate that runoff is only one of the variables affecting the dollar. The actual exchange rate is also influenced by factors such as the terms of trade, economic growth, fiscal policy, political risk and the balance of payments.
Dollar Liquidity and Risk Appetite Form a Second Channel
The US dollar is an important currency in global trade finance, cross-border lending and derivatives settlement. If the Fed's runoff is accompanied by a tightening of global dollar funding conditions, it may raise dollar funding costs and prompt some institutions to reduce leverage and cut their exposure to risk assets. When the market's demand for safe havens rises, the dollar may find support from the demand for liquidity and asset safety.
The impact of this mechanism on emerging markets is usually more complex. A stronger dollar raises the local-currency cost of servicing dollar debt, and may also trigger capital outflows, local-currency depreciation and a rise in the risk premium on local bonds. If the local central bank maintains a high interest rate to stabilise the exchange rate, economic growth and corporate financing conditions may come under further pressure.
Whether Policy Exceeds Expectations Matters More Than the Name of the Policy
The foreign exchange market's reaction to unexpected changes in policy is usually stronger than its reaction to a pre-announced path. If the scale, pace and termination conditions of runoff have been fully communicated, the marginal impact of the actual implementation on the dollar may be limited. If the Fed suddenly accelerates runoff, changes its reinvestment rules, or the market finds that reserves are falling faster than expected, volatility in exchange rates and short-term funding markets may increase markedly.
Equally, halting runoff does not necessarily cause the dollar to depreciate immediately. If runoff is halted in order to safeguard the functioning of the money market while the policy rate remains high, the market may view it as a technical adjustment rather than an across-the-board loosening of financial conditions. The reserve management purchases the Fed has conducted since December 2025 are precisely a balance-sheet operation that needs to be distinguished from quantitative easing.
(Source: Bank for International Settlements, International Spillovers of Central Bank Balance Sheet Policies, BIS Papers No.66, chapters on the transmission to exchange rates and asset prices; Bank for International Settlements, Investor Optimism Prevails over Uncertainty, published: 2024-12-10, Bond Markets and Foreign Exchange Markets chapters)
Key Events in This Round of Policy Adjustment and Their Market Implications
Runoff plan announced on 4 May 2022: the Fed announced a reduction in its securities holdings from 1 June 2022. In the first three months, the monthly redemption cap for US Treasuries was USD 30 billion, and the combined cap for agency debt and MBS was USD 17.5 billion; the caps were subsequently raised to USD 60 billion and USD 35 billion respectively. The policy focus was on reducing reinvestment in a predictable way, avoiding a larger shock to market liquidity from the active, concentrated selling of securities.
Slowing of Treasury runoff on 1 May 2024: the FOMC decided that, from 1 June 2024, the monthly redemption cap for US Treasuries would be lowered from USD 60 billion to USD 25 billion, while the USD 35 billion cap for agency debt and MBS remained unchanged. This adjustment reflected the Fed's wish to reduce the risk of reserves falling too quickly and of money-market volatility while continuing to shrink the balance sheet.
Redemption cap lowered again on 19 March 2025: from 1 April 2025, the monthly redemption cap for US Treasuries was further lowered from USD 25 billion to USD 5 billion, while the cap for agency debt and MBS remained at USD 35 billion. Runoff had not yet ended at this point, but the pace of the decline in assets had already slowed markedly.
Decision to end runoff on 29 October 2025: the FOMC announced a halt to the reduction in securities holdings from 1 December 2025. Maturing Treasury principal would instead be fully rolled over, and the principal payments from agency securities would be invested in short-term US Treasuries, marking the entry of this round of balance-sheet reduction, launched in 2022, into its termination phase.
Launch of reserve management purchases on 10 December 2025: the Fed judged that bank reserves had fallen to the ample range and instructed the New York Fed's open market trading desk to purchase short-term US Treasuries. The initial plan included around USD 40 billion of reserve management purchases, used mainly to meet the trend growth and seasonal variation in reserve demand.
Transition to the ample-reserves maintenance phase in 2026: as of 15 July 2026, the Fed's total assets were around USD 6.743 trillion and reserves were around USD 3.100 trillion. In its operating period from 14 July to 13 August 2026, the New York Fed planned to carry out around USD 17.6 billion of reinvestment purchases and an additional USD 10 billion or so of reserve management purchases. The focus of this phase had shifted from reducing the size of assets to maintaining the supply of reserves and control over short-term interest rates.
The above events show that the Fed's balance-sheet policy has multiple phases. Slowing the pace of runoff, ending runoff and reserve management purchases correspond to different operational objectives, and cannot all be interpreted as rate cuts or quantitative easing. The market impact also depends on the policy rate, Treasury debt issuance, reserve demand and the balance-sheet constraints of financial institutions.
(Source: Federal Reserve, Plans for Reducing the Size of the Federal Reserve's Balance Sheet, published: 2022-05-04; Federal Reserve, FOMC Statement, published: 2024-05-01, 2025-03-19 and 2025-10-29; Federal Reserve Bank of New York, Statement Regarding Reserve Management Purchases Operations, published: 2025-12-10)
Which Indicators Need to Be Tracked to Judge Changes in the FX and Bond Markets
The total size of the balance sheet reflects only part of the policy. To judge changes in liquidity, yields and the US dollar exchange rate, the asset side, the liability side, the policy rate and market prices need to be analysed within the same framework.
Balance-Sheet and Money-Market Indicators
Scale of securities holdings: observe the changes in US Treasuries, agency debt and MBS, distinguishing between maturity redemptions, reinvestment purchases and reserve management purchases.
Bank reserves: the pace at which reserves fall and its relationship with the banking system's demand determine whether runoff is beginning to tighten the money market markedly.
Overnight reverse repo balance: a fall in theON RRPbalance can cushion the reduction in reserves during a certain phase; once the balance approaches a low level, balance-sheet changes are more likely to be reflected directly in reserves.
Treasury General Account: an increase in the Treasury General Account usually absorbs reserves from the banking system, and tax periods and concentrated debt-issuance settlements may cause a phase of falling liquidity.
Short-term funding rates: the spreads between the federal funds rate, the repo rate,SOFRandIORBneed to be compared to identify whether reserve pressure is rising.
Treasury Supply and Term-Premium Indicators
Treasury net financing scale: a higher volume of net Treasury issuance increases the securities supply that private investors need to absorb, and may weaken the marginal support brought by the end of runoff.
Auction demand: the bid-to-cover ratio, the share of indirect bidders and the deviation of the awarded yield can reflect changes in demand from banks, foreign official institutions and asset managers.
Term premium: a rising term premium means that the change in long-term yields does not come entirely from expectations of future rate hikes, but may also come from duration supply and risk compensation.
Dealer financing capacity: an increase in Treasury inventory, a rise in repo funding costs or a tightening of balance-sheet constraints may reduce the market's ability to absorb large volumes of Treasuries.
Relative Indicators for the Foreign Exchange Market
Expected interest-rate differential: compare the expected policy rates of the United States with those of the euro area, Japan, the UK and other economies, rather than observing the Fed's unilateral policy alone.
Real yields: real yields, calculated by deducting inflation expectations from nominal yields, have an important influence on cross-border bond flows and dollar valuation.
Dollar funding costs: the cross-currency basis, banks' dollar funding spreads and offshore dollar liquidity can be used to identify changes in global dollar demand.
Risk appetite: changes in market volatility, credit spreads and emerging-market capital flows may reinforce or offset the effect of the interest-rate differential on exchange rates.
(Source: Federal Reserve, Factors Affecting Reserve Balances, H.4.1, Table 1 and Table 5; Federal Reserve Bank of New York, Monetary Policy Implementation, Reserves Management and Domestic Market Operations chapters)
Asset Allocation Needs to Distinguish Five Types of Risk
Changes in asset prices in a runoff environment do not come from a single factor. When analysing bonds, foreign exchange and multi-asset portfolios, it is necessary to distinguish between duration risk, exchange-rate risk, liquidity risk, leverage risk and policy-event risk, avoiding attributing all volatility to the size of the balance sheet.
Duration risk: long-term bonds are more sensitive to changes in yields. When the term premium rises, the price of long-term bonds may still fall even if the policy rate is unchanged.
Reinvestment risk: short-term bonds mature more quickly and are relatively less price-sensitive, but funds maturing in the future may need to be reallocated in a lower interest-rate environment.
Exchange-rate risk: the ultimate return on holding US dollar assets depends on both asset prices and exchange-rate movements. A rise in US Treasury yields does not guarantee that the dollar will appreciate in step.
Liquidity risk: a reduction in reserves, tightness in the repo market or an increase in dealer inventory may widen bid-ask spreads and raise the execution cost of large trades.
Leverage risk: the use of margin, contracts for difference or interest-rate derivatives amplifies both gains and losses. Market gaps, margin calls and changes in funding costs may cause the actual risk to exceed the price volatility of the underlying asset.
The Differences Between Three Policy Scenarios
Scenario one: the policy rate is held stable and reserve management purchases continue. This scenario is conducive to stabilising money-market reserves, but long-term Treasury yields may still be affected by inflation, fiscal supply and the term premium. The direction of the dollar depends mainly on the relative interest rates and growth expectations of the United States and other economies.
Scenario two: reserve demand falls and the Fed reduces reserve management purchases. The growth rate of the balance sheet may slow, but as long as reserves remain in the ample range, short-term interest rates need not rise markedly. The market needs to watch repo rates and changes in reserves, rather than judging the policy stance on the scale of purchases alone.
Scenario three: the economy slows markedly and drives rate cuts. Even if the balance sheet is held stable, a fall in expectations for future short-term rates may still lower Treasury yields. The dollar may come under pressure as its interest-rate advantage weakens, or it may find support when global safe-haven demand rises; the two forces need to be judged in conjunction with the specific market environment.
Runoff is therefore not suited to being interpreted as a single bullish signal for the dollar or a single bearish signal for Treasuries. The policy rate, the balance sheet, fiscal financing and global risk appetite may move in different directions at the same time, and the ultimate price performance depends on the relative strength of each variable and whether it has already been priced in by the market.
(Source: Federal Reserve, Monetary Policy Report, published: 2026-07-10, Monetary Policy and Financial Developments chapters; Federal Reserve, FOMC Minutes, published: 2026-07-08, Developments in Financial Markets and Open Market Operations chapter)
Frequently Asked Questions on Runoff and the FX and Bond Markets
Is the Fed still conducting balance-sheet runoff?
The Fed has ended the round of reduction in securities holdings launched in 2022. The FOMC announced on 29 October 2025 that it would halt the balance-sheet reduction from 1 December 2025. Since then, maturing Treasury principal has instead been fully rolled over, while the principal payments from agency securities are reinvested in short-term US Treasuries. The reserve management purchases conducted since December 2025 are used mainly to maintain ample reserves and control over short-term interest rates, and do not belong to the original runoff phase.
Do runoff and rate hikes have the same effect?
Both may tighten financial conditions, but the transmission paths differ. Rate hikes directly change the short-term policy rate, loan pricing and financing costs, while runoff mainly changes securities supply, bank reserves, the term premium and market liquidity. The impact of rate hikes on short-end yields is usually more direct, whereas the impact of runoff on long-end yields and the money market depends more on the asset structure and the state of reserves. A given scale of runoff therefore cannot be mechanically converted into a certain number of rate hikes using a fixed ratio.
Does runoff necessarily push the US dollar higher?
Runoff may support the dollar through higher yields, tighter liquidity and safe-haven demand, but there is no inevitable relationship. The dollar's movement depends more on the expected interest-rate differential between the United States and other economies, real yields, the growth outlook and risk appetite. If the market expects the Fed to cut rates sooner, or other central banks pursue tighter policy, the dollar may weaken during runoff. Whether policy exceeds market expectations usually matters more than the name of the policy itself.
Does runoff necessarily push long-term US Treasury yields higher?
By reducing the central bank's demand for securities, runoff may increase the duration risk the market needs to absorb and place upward pressure on the term premium. But long-term yields also incorporate expectations for future short-term rates. If economic growth slows or expectations of rate cuts strengthen, a fall in expected short-term rates may offset a rising term premium. Long-term US Treasury yields may therefore still fall during the runoff phase, and may also continue to rise after runoff ends because of fiscal supply or inflation risk.
Is halting runoff equivalent to restarting quantitative easing?
Halting runoff only means that the central bank no longer continues to reduce its securities holdings, and does not automatically imply quantitative easing. Quantitative easing usually has the main goals of lowering long-term yields, loosening financial conditions and supporting economic activity. Reserve management purchases mainly buy short-term US Treasuries, used to meet the trend growth in reserves and other liabilities. Judging whether policy has shifted to easing also requires taking into account the policy rate, the maturity of purchases, the scale of operations and the official policy objectives.
(Source: Federal Reserve, Policy Normalization, updated: 2025-11-26; Federal Reserve Bank of New York, FAQs: Reserve Management Purchases and Reinvestment Purchases, Reserve Management Purchases chapter)
