The Federal Reserve intended to reverse the effects of Quantitative Easing by selling off its bond portfolio in an act called Quantitative Tightening (QT). The program started in late 2017. Only about 7% of assets were sold since then and now the Fed has suddenly decided to cancel QT this year. At this rate perhaps 11% of assets will have been sold, instead of the intended 100%.
Most of the assets are intermediate term bonds or mortgage backed bonds that likely will “run off” (be prepaid) in a few years. The prepayment will occur if a recession triggers rate cuts that motivate borrowers to refinance, thus prepaying their loans. Thus, assuming a recession is coming soon, the portfolio will self-liquidate and this won’t cause rates to increase because the self-liquidation would occur during a recession when rates drop to very low levels.
The Fed originally planned on doing tapering of QE in May, 2013, eventually leading to QT, but they chickened out, fearing such an act would raise rates and trigger a recession. It has now been nearly six years since the failed attempt at tapering of QE occurred and now we get the news that we’re going to have to live with the Fed owning these bonds indefinitely, even though QE was supposed to be a brief temporary emergency program. QE started in 2009, so it has been ten years since it started. It ended in 2014 but it attempted to prevent runoff by buying more bonds, until QT started in 2017, thus the program really lasted 8 years.
The New York Fed estimated QE lowered rates 0.5%. If so, then a reversal using QT to liquidate the bond holdings would raise rates by 0.5%, or roughly 0.1% a year if sales were done over five years. It’s amazing the Fed is afraid if they raise rates 0.1% a year this will crash the economy. If someone owes $300,000 in debts and experiences a gradual 0.5% increase in rates they would pay $1,500 a year more over five years, or $1,000 after-tax if it was tax deductible mortgage interest. That’s $3 a day more over five years which means $0.60 dollar a day more in the first year of a QT program, increased annually each year by another 60 cents a day. So the Fed is saying the typical consumer can’t afford to pay $0.60 more per day, despite tax cuts and a huge drop in oil prices.
It’s funny that the Fed believes rates and inflation should be high just so they will have plenty of room to cut during a recession; yet contradicting that they want to not sell off their bond holdings (they are cancelling QT) which means if they don’t sell the bonds then rates will be lower than if they do sell the bonds. Assuming their goal is to raise rates to prepare to cut rates then they should sell the bonds, thus raising rates, so they can turn around and play hero by starting QE and lowering rates. (Except QE accidentally raised rates at the start of QE programs).
Such goofy false reasoning merely acts to shake the confidence of consumers and business so that they will react by discounting the expected probability of future income and thus consume less, thus contributing to a recession. When one’s income is capriciously confiscated by central banks the only rational way to react is to prepare for downside risk by discounting one’s estimate of income, which is recessionary.
Thus QE acts like a tax, and textbook economics says tax increases dampen growth and may trigger recessions. The windfall profit the Fed reaps from QE is donated to the U.S. Treasury so that builds the case that QE is a back door income tax. However, when QE has started, the bond market, fearful of inflation, discounted the value of bonds and lowered their market price (raising interest rates at the start of QE). When QE programs ended, rates went down again as it was demonstrated it didn’t cause inflation.
Rumor is that Japan is thinking of restarting its QE program (even though they have zero rate Treasury yields) since they are not satisfied with the results of its recently ended QE program. Because the actions of major countries emanate outwards like radio waves and influence other countries then this could provoke the other nations to match that with their own return to QE. When QE acts to lower rates this makes a currency drop in value, stimulating exports, thus tempting other countries to fight back with currency wars, forcing all of them to do QE.
Investors need independent financial advice about the risks of being fooled by central bank bubble making.