If a QT sale is pre-announced ahead of implementation, the initial fall in bond prices will result in a pre-implementation increase in the share of money in the overall portfolio: money is capital certain, whereas the value of bonds will be lower on announcement because of the expectation that bond prices will fall on implementation. To justify that relative increase in money holding ahead of the implementation of QT, the expected return on bonds must be lower in the post-announcement / pre-implementation period, requiring an expected capital loss in the period up to implementation. So the post-announcement fall in the bond price must be smaller than the implementation fall in the bond price, to create the expectation that bond prices will fall – there is some ‘undershooting’ in announcement effect relative to the implementation effect. Applying this logic over a longer time scale implies that an earlier announcement will lead to a smaller initial impact on asset prices followed by a larger number of periods where the asset price falls ahead of implementation. Furthermore, the greater the substitutability between money and bonds in the NBFI’s portfolio, the less the expected capital loss on bonds required to sustain the higher relative holdings of money in the post-announcement / pre-implementation phase. By implication, a greater part of required  Page 13  overall downward adjustment in bond prices can happen up-front on announcement.
We are working with a ‘toy model’ to make a few illustrative high level points around which to frame the QT discussion. I leave the details of the model to the Annex and discuss the intuition here. The starting point is a money demand equation for an NBFI. This relates the NBFI’s money holdings to the overall size of its portfolio and the relative return on money and risky assets. The implementation of QT implies that the NBFI will hold less money and more risky assets (the mirror image of the thought experiment that I discussed to describe the portfolio balance channel of QE transmission in the previous section). In order to persuade the NBFI to accept this shift, the return on the risky asset must rise relative to that on money. If a QT sale is announced and implemented simultaneously, the price of bonds must fall immediately in order to generate expectations of a holding period return in the future that will justify holding onto a greater share of risky assets in the portfolio following QT. The subtlety in the model is to observe that the holding period return on this risky asset will reflect (at least in part) an expected capital gain as the price of the asset changes. This matters particularly for the asset price impact of pre-announced sales.