https://www.marketwatch.com/story/t...ow-about-the-feds-accelerating-qt-11662769412
Stock-market wild card: What investors need to know as Fed shrinks balance sheet at faster pace
Last Updated: Sept. 12, 2022 at 6:43 a.m. ET First Published: Sept. 10, 2022 at 8:15 a.m. ET
By
William Watts
Accelerated ‘quantitative tightening’ could stoke volatility, analysts and investors warn
Quantitative easing is credited with juicing equity returns and boosting other speculative assets by flooding markets with liquidity as the Federal Reserve snapped up trillions of dollars in bonds after the financial crisis and amid the coronavirus pandemic. Investors and policy makers may be underestimating what happens as the tide goes out.
“I don’t know if the Fed or anybody else truly understands the impact of QT just yet,” said Aidan Garrib, head of global macro strategy and research at Montreal-based PGM Global, in a phone interview.
The Fed, in fact, began slowly shrinking its balance sheet — a process known as quantitative tightening, or QT — earlier this year. Now it’s accelerating the process, as planned, and it’s making some market watchers nervous.
A lack of historical experience around the process is raising the uncertainty level. Meanwhile, research that increasingly credits quantitative easing, or QE, with giving asset prices a lift logically points to the potential for QT to do the opposite.
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In quantitative easing, a central bank creates credit that’s used to buy securities on the open market. Purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risky assets as investors look elsewhere for higher returns.
QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.
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The unwinding of the Fed’s balance sheet that began in 2017 after the economy had long recovered from the 2008-2009 crisis was supposed to be as exciting as “watching paint dry,” then-Federal Reserve Chairwoman Janet Yellen said at the time.
It was a ho-hum affair until the fall of 2019, when the Fed had to inject cash into malfunctioning money markets. QE then resumed in 2020 in response to the COVID-19 pandemic.
More economists and analysts have been ringing alarm bells over the possibility of a repeat of the 2019 liquidity crunch....
