EC QT Is Not The Opposite Of QE

The Federal Reserve has long been clear on the sequence of events as it innovated the playbook during the Great Financial Crisis. There would be a considerable period between when the Fed would finish its credit easing operations that involved purchasing Treasuries and mortgage-backed securities (MBS) and its first-rate hike. The normalization cycle would be well underway before the central bank would allow its balance sheet to shrink. 

The early days of the recovery were weak, and a few rounds of asset purchases were deemed necessary before officials were convinced that deflationary forces were arrested and the economy had entered a self-sustaining recovery and expansion.  In 2017, nine years after Lehman failed, the Fed announced plans to gradually reduce its balance sheet by not reinvesting the entire amount of maturing proceeds. The pace would quicken quarterly until reaching $50 bln a month in Q4 18.

I recall reading only one note that warned that through its balance sheet operations the Fed would tighten more than it realized and that was from Benn Steil and Benjamin Della Rocca over the Council on Foreign Relations (November 2017 here).  While equities were cratering at the end of last year, many picked up Steil’s argument. I argued against Steil’s early warning at the time, and the subsequent iterations have not made it more compelling. 

To be sure, the argument is seductive. When the Fed’s balance sheet was expanding, officials assured us, financial conditions were easing. The econometricians calculated that every $1 trillion of asset purchases was tantamount to 15-20 bp lower interest rates. As the process went into reverse, financial conditions should be expected to tighten, and rates rise. 

Investors in risk-free assets were displaced by the Federal Reserve purchases and were forced to by riskier assets. As the Fed’s balance sheet shrank, high-risk assets would lose this bid.

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Gary Anderson 1 year ago Contributor's comment

I think it is more than weak growth and low inflation. Add to those the use of bonds as collateral like never before, and hoarding by Europe, and we see that the new normal means low bond yields and hoarding of bonds. It does not matter, QE or QT, there has been a relentless decline in bond yields over time since 1985. Bonds are the new gold. It will be hoarded and they will not act like people think they should act.