By: Tim Hayes Financial Advisor - posted in: Economy, Markets, and Interest Rates - Last updated Apr 3, 2019

The Risks of Quantitative Tightening

by | Last updated Apr 3, 2019 | Economy, Markets, and Interest Rates

Quantitative easing (QE) became quantitative tightening (QT) in October 2018. That was when the number of treasuries and mortgage-backed securities (MBS) not being reinvested ($50 billion per month) by the Federal Reserve was close to the level of maturing treasury bonds and mortgage payments from homeowners.

QT is similar to what would happen if somebody who was paying your bills suddenly stopped doing so and started to reduce your bank account by the total amount of bills previously paid.

Before that, QE remained in effect as the Fed continued to purchase new treasury bonds with the proceeds from maturing bonds. The reinvestment of maturing treasuries into new ones was, in many ways, more stimulative than the original QE, because this time the Fed could use the proceeds from maturing bonds to purchase new government debt directly.

Regarding mortgage-backed securities, the Fed has barely reduced its $1.7 trillion of them, reducing them by only 5% over the past 12 months. However, that reduction ramped up in October, when the Fed stopped buying new MBSs.

Since switching to QT, the Dow Jones Industrial Average has been down 18%, the S&P 500 has dropped 20%, and the NASDAQ has fallen 24%.

Why not just stop QT, then?

The Fed might do that. After current Fed Chair Jay Powell pooh-poohed that idea, the stock market tanked. A few days later, New York Fed President John Williams, in an attempt to clean-up Powell’s remarks, said the Fed could stop quantitative tightening in 2019 if the situation warranted that action.

Stopping QT would make the U.S. more likely to evolve into a Japanese type of economy in which, to generate economic growth, the government’s bank must create money to buy the government’s debt.

Right now, Japan’s Central Bank owns almost $4.24 trillion in Japanese government bonds – a ratio of 100% to the gross domestic product (GDP). When that happens, the economy stops being capitalistic, where banks create the public’s money supply, and morphs into a zombie-like economic system, whereby the government’s central bank funds the government with government-generated money.

These are the opinions of financial advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice.

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