INVESTING EXPLAINED: What you need to know about quantitative tightening as the cheap money of QE gets reversed
In this series, we bust the jargon and explain a popular investing term or theme. Here it’s quantitative tightening.
It’s the reverse of quantitative easing (QE), the process in which a central bank, such as the Bank of England or the US Federal Reserve, pumps money into the economy to keep interest rates low and stimulate activity.
They do this by buying up government and corporate bonds. That sends the price of the bonds up, which in turn means that the interest rate received by holders of the bonds goes down.
The lower interest rates on government bonds percolate through the economy into lower interest rates on loans for families and businesses.
Quantitative easing began as a response to the global financial crisis 13 years ago. During the dark days of the pandemic, central banks flooded the economy with even more cash to bring interest rates down to almost zero. Now they are starting to sell these bonds, that process has been dubbed quantitative tightening, or QT.
Switch: The aim of quantitative tightening is to suppress surging inflation
Why are they doing this?
The aim is to suppress surging inflation – which the central banks are also trying to combat by raising interest rates.
This is a jeopardy-ridden exercise on a colossal scale, given the sums involved. Bloomberg Economics estimates that the central banks of the G7 countries (Canada, France, Germany, Italy, Japan, the US and the UK, plus the EU) will shrink their balance sheets by about $410billion over the rest of 2022.
Is the Bank of England involved?
Since the Bank began its programme of quantitative easing to remedy the woes of the global financial crisis, it has added £895billion of bonds, including £875bn of government gilt-edged stock and £20billion in corporate bonds, to its balance sheet. It will set out a plan for sales of these gilts in August.
Until then ‘quantitative tightening will be happening in the background’. The Bank will not be replacing bonds that have matured, for example. Wits will say that the Bank is doing QT on the QT. The bank has also been raising interest rates.
What about the Federal Reserve?
The Fed has added $8.9trillion of bonds to its balance sheet. It began to ‘taper’, that is ease off, its purchases of these assets in November. Last month it embarked on tightening, planning to sell $60billion in Treasuries (government bonds) and $35billion in mortgage-backed securities each month.
US inflation is running at a 40-year high of 8.3 per cent. The Federal Reserve’s hope is to ease such pressures and to create a soft landing for the economy, rather than bringing about a recession.
Can the Fed pull this off?
Some major figures are sanguine about the programme. But others are concerned, pointing out that previous attempts to reduce inflation have triggered a recession.
The sceptics include Jamie Dimon, boss of JPMorgan Chase. He contends stock markets – which were hugely inflated by QE – have already fallen sharply, and that there could be a further descent as a result of QT.
Dimon said: ‘Right now, it’s kind of sunny, things are doing fine, everyone thinks the Fed can handle this. That hurricane is right out there, down the road, coming our way. We just don’t know if it’s a minor one, or Super Storm Sandy.’
Americans who, like the rest of the world are as baffled by QT as they were with QE, can only sit and wait.