Quantitative monetary easing is credited for juicing stock market returns and boosting other speculative asset values by flooding markets with liquidity as the Federal Reserve snapped up trillions of dollars in bonds during both the 2008 financial crisis and the 2020 coronavirus pandemic in particular. Investors and policy makers may be underestimating what happens as the tide goes out.
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. However, with the economy recovering and inflation rising the Fed began shrinking its balance sheet in June, and is doubling the pace in September to its maximum rate of $95 billion per month. This will be accomplished by letting $60 billion of Treasurys and $35 billion of mortgage backed securities roll off the balance sheet without reinvestment. At that pace, the balance sheet could shrink by $1 trillion in a year.
Hedge-fund giant Bridgewater Associates in June warned that QT was contributing to a “liquidity hole” in the bond market.
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