EC QT Is Not The Opposite Of QE

The narrative is straight-forward and logical. There is one problem: the facts. With the Fed buying fewer Treasuries and the government issuing more, bond yields should have risen but instead, have fallen. The US 10-year yield peaked in November near 3.25% and today are below 2.70%.  The impact on mortgage rates has also been counter-intuitive. Thirty-year mortgage rates are closer to 4.5% than the 5% rate seen in the middle of Q4 18.

What about equities? The S&P 500 reached a record high about a year after the Fed’s balance sheet began shrinking. The sell-off in Q4 18 was violent. Investors were looking for a culprit, and Steil’s balance sheet argument was ready-made and helped by a tweet from President Trump that also referred to the reduction of the balance sheet. 

Equities have come roaring back, not just in the US but also the riskier emerging market equities. The Federal Reserve’s rhetoric has changed, and it may raise rates less this year less than the two times signaled in December. However, the balance sheet continues to shrink, though operationally the pace is closer to $40 bln a month than $50 bln. 

If we are to conclude that Quantitative Tightening (QT) is not really tightening financial conditions, what are we to make of Quantitative Easing (QE)? The econometricians want to measure quantities of both flows and stocks, but price changes do not align. 

The conventional narrative puts too much weight on quantities and not enough emphasis on signaling. If QE was really about quantities, it is difficult to explain the apparent diminishing impact after the first round, or the seemingly less impactful though greater quantities were involved in the eurozone. Indeed, in the six weeks or so that the ECB has stopped buying assets, bond yields have fallen. The Germany 10-year yield fell to a two-year low recently, a little below 10 bp Its curve is negative out nine years. For its part, the Bank of Japan has gradually reduced the number of government bonds it buys without having a perceptible impact, and the 10-year yield is a little below zero. 

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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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.