What it is
Quantitative tightening is the reduction of a central bank's balance sheet after a period of asset purchases. In its usual form it is passive: securities are allowed to mature without the proceeds being reinvested, up to a monthly cap, rather than being sold into the market. It is the reverse of quantitative easing, but it is not symmetric with it in either speed or effect.
How it works
Mechanically, when a bond held by the central bank matures and is not rolled, the Treasury issues new debt to private investors and reserves in the banking system fall. The path of reserves also depends on the Treasury's cash balance and on usage of the overnight reverse repo facility, so the drain on bank reserves can be much slower or faster than the headline runoff figure suggests. The main channel of effect is the term premium and the supply of duration to private investors, rather than the policy rate itself.
How traders use it
Market participants watch it for its influence on the shape of the curve, on funding markets and on general risk appetite. The practical constraint is the money market: as reserves approach the level the banking system genuinely needs, repo rates become volatile, which is what forced an earlier programme to be halted in 2019.
Where it breaks down
The magnitude of the effect is genuinely contested among economists, and estimates of how many basis points of term premium a given pace of runoff adds vary widely. The popular practice of overlaying the balance sheet on an equity index and declaring causation ignores that both respond to the same policy cycle. Note also that an announced cap is a ceiling rather than a schedule: actual runoff depends on the maturity profile of the portfolio and is frequently below it.
Educational reference. This entry describes how a concept is defined and used. It is not investment advice, not a recommendation, and not a signal. Any rule you build from it should be tested with realistic costs before it is traded, and no historical result guarantees a future one.