📍 Why did the Fed decide to stop QT at this time: The stories of QT1, the 2019 Repo crisis, and QT2 all point to the key issue being liquidity in the US financial system

📌Over the more than 17 years since the 2008 crisis, there have been 3 crucial periods shaping the Fed's view on liquidity: QT1, the 2019 repo incident, and QT2. All three reflect a common rule: The US financial system cannot withstand liquidity being drained too deeply, and the level of bank reserves is the boundary for the Fed to choose between QT or QE.

📌QT1 period (2017-2019): The Fed shrinks its balance sheet but misjudges the minimum reserve threshold
- The Fed did QE after the 2008 crisis (including QE1, QE2, and QE3, leading to surging asset prices from 2009-2014). Afterwards, QT1 (September 2017) marked the end of the cheap money era, aiming to return the balance sheet to normal. The Fed gradually reduced its bond holdings, but more importantly, bank reserves were continuously eroded.
- During QT1, bank reserves fell from a very abundant level to near the minimum required for safe operation. The Fed believed there were still excess reserves, but in reality, post-crisis reserve needs had changed.

=> QT1 led to system-wide stress:
- The Fed believed reserves could be further withdrawn without affecting the system.
- But in reality, the banking system did not have as much flexible liquidity as the Fed estimated.
- As QT continued, available reserves dropped to the minimum level the market needed.

📌This led directly to the 2019 Repo crisis:
- In September 2019, something unusual happened: the repo market (the safest because it’s collateralized by US Treasuries) suddenly lost lenders. Interest rates spiked within a few hours.
- Bank reserves had dropped extremely low, and the funding market could not meet large payment needs.
- Banks were almost unable to lend short-term.
-> The repo spike was the clearest sign that the system no longer had enough liquidity to absorb short-term shocks. This is the natural reaction of a system whose reserves have just been drained by QT.
The Fed had to immediately halt QT1 and inject large-scale liquidity to stabilize the money markets (the Fed also admitted it had misjudged the minimum reserves required for the system).

📌QT2 period (2022-2025): The Fed continues to withdraw liquidity
- QT2 took place as the Fed fought inflation post-Covid and shrank the balance sheet by nearly $2.3 trillion (the largest reduction ever).
- Although bank reserves dropped, they were still nearly double the QT1 bottom, avoiding the risk of a 2019 Repo crisis repeat.
- Most of the liquidity drained came from the Reverse Repo tool (pulling down RRP instead of directly reducing bank reserves).

📌Currently, the Fed has decided to stop QT2 while the system is still in a safe zone, with only slight pressure from SOFR. The Fed probably wants to stop before any tension appears in the funding markets.

🎯Overall across the three periods: The Fed has learned the system's boundary

If you only look at the scale of liquidity injection/drain, QT2 was more effective than QT1, as QT1 was a failure for the Fed since the system ran out of reserves. After QT1, the US financial system established a minimum level of bank reserves that the Fed cannot breach. The Fed has reached a boundary that history shows cannot be crossed.