By Alessandro Giovanni Borghese and Christopher Anstey Tokyo/New York
For a decade, investors around the world have ridden a rising tide of more than $12tn – the extra cash pumped into the global system by key central banks to counter the deepest financial crisis since the Great Depression and its aftermath. Now that flow of so-called quantitative easing is turning to the ebb of quantitative tightening, and markets are – perhaps not coincidentally – showing increasing volatility.
1. What’s quantitative
The easy answer is that it’s the opposite of quantitative easing, or QE. Milton Friedman had proposed a type of QE decades ago, and the Bank of Japan pioneered its use in 2001 after it had run out of conventional ammunition by lowering its benchmark short-term interest rate to zero. In QE, a central bank buys bonds to drive down longer term rates as well. As it creates money for those purchases, it increases the supply of bank reserves in the financial system, and the hope is that lenders go on to pass that liquidity along as credit to companies and households – spurring growth. To avoid the impression that the central bank is just financing the government, it buys the bonds in the secondary market rather than directly from the Treasury or finance ministry.
2. When did QE switch to QT?
The US Federal Reserve applied QE in force starting in 2008, buying up bonds to revive the flow of credit to a shrinking economy. It stopped increasing its stockpile of bonds in 2014, and now it’s shrinking its balance sheet. While the BoJ and European Central Bank are still in the QE business, they’re tapering their purchases. Their collective balance sheet peaked in March. That means the era of QT is upon us.
3. How does QT work?
The Fed is now letting up to $40bn of its bond holdings mature every month without replacing them, a cap it will raise to $50bn later in the year. That takes money out of the financial system, as the Treasury Department then finds new buyers for its debt. The Fed describes the winding down of its balance sheet as part of a “normalisation” of its policy stance, along with rate hikes, given the solid performance of the American economy and rising inflationary pressures. The ECB, BoJ and Bank of England were among the central banks that deployed QE and may at some point start shrinking their own balance sheets as the Fed is now doing.
4. How much QT has there been?
Since the ECB and BoJ are still buying securities, so far the biggest impact has come more from QE being scaled back than from actual unwinding. But the shift is significant. The combined G-3 central banks’ balance sheet increased by $76bn in the first half of 2018, compared with a $703bn jump in the prior six months. That suggests well over half a trillion dollars worth of liquidity injection went missing from the markets. Balance sheets can be affected month-to-month by items other than just the QE programmes, but the direction is clear. And the pace of change is likely to increase: The Fed’s draw-down will step up to $50bn a month in October, the ECB is scheduled to terminate QE by year-end and the BoJ has been opportunistically trimming its bond purchases.
5. How are the markets reacting?
Although the Fed’s unwinding is a slow and gradual process, it has still roiled markets. QT has been the primary driver of asset-class performance this year, according to Bank of America Merrill Lynch analysts. Declines have hit markets from emerging-nation stocks to corporate bonds, responding to a climb in yields on benchmark government debt. Treasury bills reacted particularly quickly to the shift (alongside rising issuance from the Treasury), with rates climbing steadily in recent months. That’s helped propel strengthening in the dollar, which reached a one-year high last month. Markets have also been more volatile this year compared to 2017.
6. Who are the winners and losers of QT?
The assets that were QE winners are QT losers and vice-versa. Longer-duration bonds have held up so far, though many predict declines – JPMorgan Chase & Co chief executive officer Jamie Dimon for one has warned of 10-year Treasury yields climbing past 4%, from less than 3% now. Investors in money markets are big winners. They’ve gone from earning next-to-nothing to drawing almost 2%. The stronger dollar means that emerging markets in particular are facing strains, as investors worry about the ability of developing countries to pay off their dollar-denominated debt.
7. Does anyone think this is a bad idea?
Yes. The damage to emerging markets has sparked calls for the Fed to be mindful of the ramifications of its normalisation campaign. India’s central bank governor, Urjit Patel, wrote a column in the Financial Times in June urging the Fed to ease off on QT, warning that a “crisis” in dollar funding will be inevitable if it doesn’t – given how the US fiscal deficit is widening. In Europe, populist political parties may agitate against the ECB drawing down its holdings of debt and – by extension – potentially pushing up government borrowing costs. Some Fed officials are also calling for discussion about bringing an earlier end than anticipated to the balance-sheet contraction, given some signs of tightness in the market for overnight cash.
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