A screen shows the Fed interest rate announcement as a trader works (inside a post) on the floor of the New York Stock Exchange (NYSE) in New York, June 15, 2022.
Brendan McDermid | Reuters
The US Federal Reserve last week took on a hawkish tone about fighting inflation through monetary policy, but analysts are concerned about the potential threat from its continued tightening strategy.
Fed Chairman Jerome Powell warned that The US economy will face ‘some pain’ as the central bank continued to raise interest rates aggressively, causing the market to sell off once again on the rising prospect of a recession.
Markets around the world sell-off while clearly confirming that tightening monetary policy is at the forefront, potentially exacerbating recession risks as policymakers focus on the Fed’s deposit rate as a key anti-inflation tool .
However, in a research note on Tuesday, analysts at London-based CrossBorder Capital suggested that the “quantitative liquidity aspect” is being overlooked, with the Fed slashing its balance sheet. – or quantitative tightening – has a disproportionate effect on the economy.
“The Fed sees QT/QE acting like an ‘air conditioning unit,’ but we treat QT like a crumbling balloon that will eventually reverse into another QE,” said CEO Michael Howell. ,” said CEO Michael Howell.
CrossBorder warned ahead of Powell’s Jackson Hole speech that there was a growing risk of “an upcoming major policy error” from the Fed’s course of action, specifically “the impact of excessive QT on financial stability.”
Quantitative tightening
Quantitative tightening is a monetary policy tactic used by central banks to reduce liquidity and shrink their balance sheets, usually by selling government bonds or allowing them to mature. move them out of the bank’s cash balance.
CrossBorder Capital believes that central banks are sucking too much liquidity out of financial markets too quickly, and Howell pointed to a recent hawkish shift of some European Central Bank policymakers, which he said could destabilize the euro and ultimately pivot liquidity from central banks in 2023.
“Our concern is that QE/QT has undue effects on financial stability, with a contraction of nearly one-third of the Fed’s balance sheet proposed equating to about 5 percent of the score. added to the Fed Funds,” Howell said,
“At some point in 2023, the Fed will be forced to pivot towards getting the balance sheet up again and the US dollar falling. Until this is reached, the next few months will prove to be a bit of a stretch. larger QT (quantitative tightening). This will terrify the market.”
Concerns about QT were echoed by Mazars Chief Economist George Lagarias, who urged traders and investors to forget what they had heard from Powell in Jackson Hole and focus instead on his assets. Fed as a leading indicator.
The Fed is increasing the limit on quantitative tightening from $45 billion to $95 billion. Meanwhile in September, the ECB is ending quantitative easing, albeit with a program to limit the dispersion between borrowing rates in more indebted and less indebted member states.
“Will [the Fed’s cap increase] extract money from the market at a fast rate? Its true intentions will be expressed in that area, not in policy speeches,” Lagarias said Tuesday.
“In the meantime, investors should worry about the long-term impact of the Fed’s stance. A recession could turn into a deep recession. Inflation could turn into deflation.”
He notes that emerging markets and US exporters had to endure the strong dollarswhile consumers are “at the end of their relationship”, especially in the current circumstances, in which central banks are implementing policies towards stifling wages. in the cost of living crisis.
“The moment when central bank independence is in place may not be far away,” Lagarias speculates.
Underestimate the impact of QT?
When the Fed returned to its bond portfolio in 2018, it led to the infamous “furious fury” – a sharp sell-off in the market, prompting the central bank to adjust policy and make slow speed of treasury sales.
“Central banks argue that they can afford to reduce their bond holdings because commercial banks have a lot of reserves and don’t need the central bank to hold so many government-issued bonds. “, said Garry White, chief investment commentator at British investment manager. Charles Stanley, said in a note ahead of Powell’s speech at Jackson Hole.
“More of that could be held by the private sector at the expense of their bankroll. It’s possible that central banks underestimate the impact of significant quantitative tightening.”
Governments will aim to sell off large amounts of debt in the coming years, with fiscal policy becoming unprecedentedly loose due to the Covid-19 pandemic in early 2020.
White suggests that ending central bank bond purchases would mean governments paying higher interest rates to settle their debt.
“If central banks turn into sellers of government bonds, then the difficulty will increase,” he said.
“Currently, the main goal of the Fed and the ECB is to end all new bond purchases and allow portfolios to run out as governments have to repay their bonds at maturity.”
Beat Wittmann, president and partner at Zurich-based Porta Advisors, also recently warned of the growing risk of a “major financial crash” causing market capitalization status later this year.
“The list of weak link candidates is quite long and includes zombie-style global banks in Europe, LBO [leveraged buyout] Wittman said.
