December 17, 2025
Dear Investors and Friends,
After our November letter, several readers asked an important and very reasonable question:
Why would the Federal Reserve even consider quantitative easing if the economy is solid?
It is a perceptive question because for most of modern economic history, quantitative easing was reserved for periods of genuine distress. It was the tool of last resort in a crisis. When markets seized in 2008, when liquidity evaporated in 2020, when confidence was fragile and credit was tightening, the Fed stepped in as the shock absorber.
Today, however, the economy looks far from fragile. Growth is steady, unemployment is low, incomes are rising, and corporate balance sheets are healthy. In that context, the idea of additional liquidity seems counterintuitive.
Yet the answer lies not in the state of the economy, but in the plumbing of the financial system.
QE Today Is Not About Stimulating Growth
One of the biggest changes in monetary policy over the last decade is that quantitative easing is no longer used solely to stimulate demand. Increasingly, QE is being used to ensure the smooth functioning of the financial system.
The financial system depends on ample reserves, which are the banking system’s form of cash. Banks, money market funds, broker dealers, and the Treasury market all rely on these reserves for daily operations. Warren Buffett likes to say that cash is like oxygen. When it is there, you never think about it. When it is not, nothing else matters. The same is true of reserves in the financial system. They stay in the background when abundant, but become the only thing that matters when scarce.
The level of reserves in the banking system is not set by banks themselves. It is set by the Federal Reserve and influenced by the Treasury’s financing needs. When the Fed expands its balance sheet, reserves rise. When the Fed shrinks its balance sheet, reserves fall. In other words, the supply of cash in the financial system is a policy choice, not a market outcome.
When reserves fall too low, stress can emerge quickly. Funding markets can wobble. Repo rates can spike. Treasury trading can become unstable. None of these stresses reflect weakness in the economy. They reflect insufficient liquidity in the banking system.
Why Liquidity Can Matter Even When the Economy Is Strong
Ray Dalio recently described this dynamic in simple terms. Financial wealth can grow very large relative to the amount of money available to settle transactions in the financial system. That imbalance can feel stable while markets are rising, but it becomes fragile when there is a sudden need for cash and investors are forced to sell assets to raise it.
In moments like that, the Federal Reserve often steps in not because the economy is weak, but because the system needs money to keep functioning smoothly.
This is not theoretical. It happened in 2019. The economy was strong, unemployment was low, and yet the Fed was forced to expand its balance sheet after a sudden shortage of reserves caused stress in short-term funding markets. The Fed eased not to stimulate growth, but to stabilize the pipes of the system.
We may be approaching a similar point today.
Why the Pressure Is Building Now
While the importance of the Treasury market is not new, several forces have changed meaningfully in recent years, increasing the likelihood that the Fed may need to act.
Large and persistent federal deficits: The federal government is issuing enormous quantities of Treasury securities to finance its deficits. If private demand cannot absorb this supply without disorderly moves in yields, the Fed may feel compelled to provide liquidity to maintain orderly markets.
Banks have limited balance sheet capacity: Post financial crisis regulations strengthened the banking system but also constrained balance sheet flexibility. Banks and dealers do not have unlimited capacity to absorb Treasury issuance, making the system more sensitive to supply shocks.
Reserves have been steadily declining under quantitative tightening: Two years of QT have meaningfully reduced reserves. As reserve levels approach lower thresholds, the system becomes more fragile and more vulnerable to sudden liquidity stress.
Why the Fed Cannot Ignore These Pressures
The Treasury market serves as the primary collateral for the global financial system. If liquidity deteriorates or trading becomes unstable, the consequences extend far beyond U.S. borders. Maintaining smooth functioning in this market has therefore become a core responsibility of the Federal Reserve.
Implications for Investors
If the Fed resumes balance sheet expansion while the economy is still strong, the consequences may differ from past rounds of quantitative easing.
Inflation risk may rise: Injecting liquidity into a healthy economy can reignite price pressures. Real yields may drift lower even as nominal volatility increases.
Bond demand dynamics could shift: Additional liquidity can temporarily support bond prices, particularly at longer maturities. Longer term outcomes will depend on inflation expectations and fiscal credibility.
Credit spreads may narrow further: Liquidity often compresses spreads, but starting points matter. With spreads already tight, the margin for error is limited.
Equity valuations may continue to climb: As we have discussed in prior letters, asset prices can rise not because fundamentals improve, but because more money is flowing into the system.
RCM’s Perspective: Disciplined in Every Regime
At Roosevelt Capital Management, we do not attempt to predict the Federal Reserve’s next move. Instead, we focus on building portfolios that are resilient across many regimes, including those where liquidity returns before it appears necessary.
We continue to emphasize short to moderate duration, careful credit selection, and diversified exposure across the yield curve. Our goal is to preserve flexibility, protect purchasing power, and anchor portfolios in real value rather than speculation.
If quantitative easing returns, we will adapt. If it does not, we will adapt. In every environment, our responsibility remains the same: steady stewardship of the capital entrusted to us.
As always, we will watch the data rather than the headlines and remain guided by the principles that have served our clients well across every cycle.
In an environment where liquidity matters as much as fundamentals, understanding how money flows through the system is more important than ever.
With gratitude,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.