As the Fed is steadily progressing through its balance sheet normalization plan, it’s worth checking in on a few charts that highlight the path to normalcy, and some of the potential stumbling blocks along the way. This article provides an update and follows on from a previous post “5 Charts on Quantitative Tightening”.
The beginning of large-scale asset purchases (or QE – Quantitative Easing) in the wake of the financial crisis was a grand monetary policy experiment, and we are now entering into another grand monetary policy experiment which will test portfolio managers and asset allocators.
Already we have seen plenty of examples of how Fed tightening is presenting ripple effects across global markets, with a stronger US dollar and higher interest rates putting stress on emerging markets, shaking commodities, and presenting more uncertainty for stock prices and bond yields. Given the importance of monetary policy for the economic and financial market outlook, this is a topic worthy of your attention.
The key takeaways on quantitative tightening (or QT) are:
1. Fed Balance Sheet Normalization Plan: As outlined in the Fed’s plan for balance sheet normalization, the Fed has embarked on a progressive quantitative tightening program whereby it will allow its balance sheet to be run down over time. The chart below shows approximately how this will play out (all going to plan). Currently, the monthly pace of QT is a potential $24B in Treasuries and $16B for asset-backed securities (combined $40B), all going to plan, this will rise to $30B in Treasuries and $20B in ABS (combined $50B) in Q4 this year. For context, at its height QE3 was running at a pace of $85B per month, so the pace of balance sheet shrinking will not be too far off the pace of expansion back in the days of experimental easing.
