If you paid close attention to the Fed’s latest interest rate decision, you still might have missed something. In fact, hardly any major media is picking it up, but it’s important to markets. The Fed is back in the bond buying business. So, what does that mean?

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Last year, the Fed announced that it would start rolling off or selling bonds from its holdings as part of its quantitative tightening program. During the pandemic, the Fed’s balance sheet had ballooned to an unprecedented level, and the extra cash infusion to the markets was seen as one of the contributing factors to inflation. Since starting its tightening cycle, the Fed had sold about $600B as part of its Quantitative Tightening cycle. Since the start of the banking chaos, it has bought around $400B in bonds, or it “reversed” about two thirds of the QT.

What exactly is QE?

The Fed is normally buying (and selling) bonds in the market as part of its daily activities to regulate liquidity and inflation. The mere fact that the Fed is buying bonds doesn’t necessarily mean that it’s engaging in quantitative easing, as it’s understood by the markets. The problem is that the line between regular operations and quantitative easing has become somewhat blurred since 2008, when the Fed started intervening on a massive scale.

QE is generally understood as a large and prolonged buying of bonds in order to increase market liquidity. With the balance sheet ballooning to nearly $9.0T and the Fed rolling off $95B a month in holdings, what exactly constitutes “large” has sort of evolved. And when the Fed starts buying, depending on circumstances, that “prolonged” aspect isn’t necessarily clear from the start.

Clearing up uncertainty

One of the ways to determine whether the buying is or isn’t QE is whether the Fed says so. And the Fed did not make any announcements that it would restart quantitative easing, so as far as the official narrative is concerned, the $400B in buying over the last three weeks or so amounts to regular operations and isn’t QE.

But the practical impacts on the market are both the same and different at the same time. Buying bonds puts liquidity into the market and drives down yields. That explains the sudden narrowing in the yield curve inversion of the last few weeks. But without announcing a new bond buying program, the market can’t expect this buying to last very long, and will likely not have as big of a reaction beyond the bond markets and the dollar.

How much does history repeat itself?

A repeated mantra of brokers is that past performance does not guarantee future results. But, it can give some insight. There were similar circumstances recently: the Fed raised rates, had started QT, then there were worries about market liquidity, so the Fed started to buy bonds without an official announcement. That was in late 2019 – right before the massive expansion in the balance sheet in 2020.

Of course, the move in 2020 was due to the pandemic, which is probably less likely this year, although can’t be completely ruled out. More to the point, as long as the balance sheet remains below $9T, then the Fed is still simply “reversing” the QT it has already done. But if the Fed’s holdings move beyond that point, the financial press might suddenly start taking notice, which could affect the markets.

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