Shenwan Hongyuan Group: The QE era may have come to an end, and the Fed's balance sheet expansion has entered a "new normal"

Shenwan Hongyuan Group released a research report stating that after the FOMC meeting in December 2025, the Federal Reserve restarted the Reserve Management Purchase (RMP), igniting an optimistic sentiment of "QE-style" liquidity easing. However, in reality, the QE era may have already come to an end until the next economic crisis. The expansion of the Fed's balance sheet has entered a "new normal", but it cannot be compared with QE in terms of quantity, quality, and market implications. The main points of Shenwan Hongyuan Group are as follows: 1. From tapering to expanding the balance sheet: The process of "normalizing" the Fed's balance sheet Since the global financial crisis of 2008, the Fed's balance sheet has been expanding uncontrollably. From 2008 to 2026, the Fed has implemented four rounds of expansion (QE) and two rounds of tapering (quantitative tightening, QT), including one round of reinvestment and two rounds of RMP. As of the end of QT2 in November 2025, the Fed's total assets were still over $6.6 trillion, more than 7 times higher than in early 2008 and 1.7 times higher than at the end of QT1 in September 2019. At the December 2025 FOMC meeting, the Fed restarted RMP, marking the beginning of the "normalization of expanding the balance sheet" phase. In terms of quantity, it will initially be $40 billion per month, but may slow down to $20-25 billion after May. In the medium term, the speed of RMP expansion may match the nominal GDP growth rate. In terms of maturity, SOMA will mainly purchase Treasury securities with maturities of less than one year, with 75% in the 1-4 month range and 25% in the 4-12 month range. In principle, only Treasury bonds with maturities of up to 3 years will be purchased if there is a shortage of Treasury securities. RMP and QE cannot be compared in terms of "quantity", "quality", and market implications. The essence of RMP is a new type of open market operation (OMO) under the framework of adequate reserves, which is fundamentally different from unconventional QE. The goal of RMP is to maintain an adequate supply of reserves, unrelated to the monetary policy stance, and does not affect the degree of monetary policy accommodation. QE is an unconventional policy tool under the zero lower bound constraint, aimed at lowering long-term interest rates (risk-free rate or risk premium) and further easing financial conditions. 2. The "tool" of the balance sheet: "adequate reserves" framework separates policy rates from reserve quantities After the GFC, the Fed's policy operating framework underwent a paradigm shift from "scarce reserves" to "adequate reserves" - the change is in the way of controlling interest rates, not the interest rate "reaction function". During the period of scarce reserves, the Fed controlled interest rates through high-frequency open market operations, and reserves followed the "short board principle". During the period of adequate reserves, the Fed controlled interest rates through an "interest rate corridor", and reserves followed the "long board principle", only occasionally and actively conducting OMO when there was a shortage of reserves. The Fed's monetary policy framework faces the "trilemma of the three elements": the difficulty of balancing the efficiency of controlling interest rates, the cost of the balance sheet, and the frequency of open market operations. The framework of scarce reserves has low effectiveness in controlling interest rates, high frequency of open market operations, but low cost of the balance sheet; the framework of adequate reserves has high effectiveness in controlling interest rates, low frequency of open market operations, but high cost of the balance sheet. In either framework, the policy rate is the "barometer" of the degree of monetary policy accommodation, not the quantity of reserves. Under the framework of adequate reserves, policy rates and reserve quantities are separated, belonging to two different decision-making systems. The policy rate still applies to the "Taylor rule" framework, and the Fed needs to balance between the "dual mandate" (maximum employment and price stability). 3. The end of the QE era: "zero interest rate" is a necessary condition for restarting QE or YCC Central bank balance sheets are not a one-way street that can only expand and not contract. In fact, the Fed implemented QE from the Great Depression to World War II, and the Bank of Japan implemented QE from 2001 to 2006, then both returned to the framework of scarce reserves. Whether and to what extent the balance sheet will "shrink" after QE depends mainly on two factors: the demand for reserves (related to financial regulation) and the duration of securities held. Under non-war or non-zero interest rate conditions, the Fed is highly unlikely to lower US bond rates through QE or YCC. Excluding the extreme scenario of a hot war, the policy practices of global central banks indicate that zero interest rates are a necessary condition for QE or YCC. The logic is very simple: the goal of QE or YCC is to lower long-term interest rates, and the most effective way to achieve this goal is to lower interest rates to zero (or negative). From the perspective of the Fed's rate-cutting cycle, 2026 may be the "last leg" of the "rate-cutting wave" of Western central banks. In the conventional monetary policy range, the interest rate is "important", and expanding the balance sheet is "unimportant". Therefore, 2026 is not the starting point for an "abundant liquidity feast" in the sense of the Fed expanding the balance sheet, but the "last leg" of a period of accommodative monetary policy due to limited room for rate cuts. From a market implications perspective, it is suggested to "rationally ignore" the impact of RMP on the capital market. The impact of RMP on US stocks is indirect and defensive - it may reduce the likelihood of stocks being sold off due to liquidity shocks, but it is not a basis for going long. In other words, maintaining an adequate supply of reserves helps smooth out volatility in US stocks but does not change the direction. The situation for US bonds is similar. Risk warning: Escalation of geopolitical conflicts; US economic slowdown beyond expectations; Fed unexpectedly turning "hawkish".