Column: Fed’s Powell could use Jackson Hole to dispel QT thinking
/cloudfront-us-east-2.images.arcpublishing.com/reuters/JLT6KBEX3VJ6ZK3WLJNXMOU7XE.jpg?resize=780,470 "Column: Fed's Powell could use Jackson Hole to dispel QT thinking 1")
Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, US, July 27, 2022. Reuters/Elizabeth Frantz/File photo
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ORLANDO, Fla., Aug. 12 (Reuters) – The US Federal Reserve’s plan to open its bond-bloated balance sheet has held back its dramatic interest rate hikes in recent months – but it could make a comeback in Jackson Hole. Is.
Perhaps there isn’t much guidance Fed chief Jerome Powell can give markets on the policy rate outlook at the annual central bank in Wyoming resort later this month — not least because the Fed itself admits there’s little long-term visibility on inflation or the economy. just.
The Fed’s stance on rates seems fairly clear – it will continue to raise them even in restrictive territory, and hold them until inflation and inflation expectations are on a sustainable path toward its 2% target.
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But anything Powell says about “QT” and slashing the bank’s nearly $9 trillion balance sheet will draw a lot of attention — because investors and policymakers have been so vague to date that they’re about to take such liquidity withdrawals. How to see the impact Aggressive rate-increasing campaigns.
Quantitative tightening, in contrast to quantitative easing, will see the Fed reducing its Treasury and mortgage-backed securities (MBS) holdings. The program began in June and will grow to $95 billion per month in September.
Under these assumptions, the balance sheet would shrink by approximately $2.2 trillion by the end of 2024 by limiting reinvestment. There are no one-time property sales plans as of now.
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unknown effect
So Qt is not even fully operational. But it’s hard to see that the process would be akin to “watching the paint dry,” in the words of former Fed Chair Janet Yellen, before the Fed’s last QT venture in 2017.
Simply put, no one knows how shrinking a central bank’s balance sheet by $2 trillion will affect borrowing costs, financial conditions, and market functioning.
That would be true in the best of times, no matter when the economy is teetering with – or perhaps has already entered – recession, inflation near 40-year highs, yield curve rarely more inverted. , and the bond market is plagued by high volatility and thin liquidity.
The Kansas City Fed’s Jackson Hole symposium on August 25-27 will be the perfect platform for Powell to give Powell a little more visibility or reassurance on QT, no matter how thick the fog of uncertainty is.
But is he?
Joseph Wang, a former senior trader at the Fed’s open markets desk, is skeptical.
“The Fed wants QT to run on autopilot. Powell has already said that he thinks the bond market can handle QT, but market liquidity has been very bad lately. I don’t think QT is priced in the market. is,” says Wang.
Speaking to reporters last month after the Fed raised rates by 75 basis points for the second consecutive meeting last month, Powell said he fully expected the bond market to absorb the excess supply.
He also estimated that it would take up to two-and-a-half years for bank reserves to fall to a level below which the banking system finds it difficult to function smoothly.
marginal buyer
But there is significant doubt over these assumptions, and there are other unknowns to consider.
For example, who will be the marginal buyer of these bonds? Money market funds are pooling their cash in the Fed’s reverse repo facility, hedge funds are taking painful losses and have little appetite to leverage, and banks and dealers’ ability to hold more bonds appears to be limited.
Can Powell offer his thoughts on this? Or how might the most inverted yield curve in more than 20 years affect QT plans?
Last month, two Fed research papers warned that balance sheet reductions could have negative consequences for an already tense Treasury market and could lead to an uncomfortably sharp rise in interest rates.
A $2.2 trillion cut over three years could raise rates by 74 basis points – nearly three times more than “normal time”. Meanwhile, the limited ability of pensions and mutual funds to absorb the Fed’s bonds could make market conditions “more disruptive.” read more
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Roberto Perli and Benson Durham at Piper Sandler – both former Fed employees – note that average daily Treasury market yield changes are at levels historically associated with recessions, crises and extreme volatility.
Should these conditions persist, the life expectancy of QT may be reduced.
“The longer QT moves forward, the more stress the market is likely to experience as the discrepancy between dealer capacity and the size of the private market will widen. A potential cut in QT expectations will be a positive for both risk asset prices and Treasury prices. ” he wrote on Tuesday.
Powell and his colleagues can keep an eye on the Atlantic to assess the market’s impact from Qt. The Bank of England is on track to shrink its balance sheet, and is about to begin actively selling bonds. read more
Related columns:
– Bank of England review may raise the bar for future QEs (August 12) Read more
– Deep US curve inversion accelerates the slowdown that was predicted (August 11) Read More
– Beat inflation? ‘Team transitory’ emerges again (August 3) Read more
(The views expressed here are those of a columnist writer for Reuters.)
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Reporting by Jamie McGyver; Editing by David Holmes
Our Standards: Thomson Reuters Trust Principles.
Opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from prejudice, under the Trust Principles.
Jamie McGyver
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