What Will Quantitative Tightening Look Like?

 

What will quantitative tightening (QT) look like? We've been trying to understand this new type of monetary policy since its inception. Its main goals include reducing the size of the Fed's balance sheet, raising mortgage rates, and bringing inflation under control. However, we've hit a few bumps along the way. Now, let's take a closer look at the process itself.

QT is a type of monetary policy

In addition to raising the interest rate, the Federal Reserve has also introduced quantitative tightening, or QT. The policy is intended to tighten monetary policy by shrinking the Fed's balance sheet. The gradual shrinking of the Fed's balance sheet was designed to prevent the financial system from starving for liquidity and unnerve markets. However, the effects of QT were so severe that the Fed reverted course and started buying U.S. Treasury bills instead. While the Fed initially announced QT, the pace of withdrawals slowed to a crawl in October.

QT and QE are complementary to one another. QE is designed to boost economic activity and stimulate a struggling economy, while QT is designed to slow down the growth of the money supply. The pace of each type of monetary policy is dependent on the economy and is best suited for a given country. As a general rule, however, both types of policy are intended to stimulate economic activity.

It reduces the size of the Fed's balance sheet

After spending more than a decade supporting the US economy, the Federal Reserve has decided to cut back on its quantitative easing program. This unconventional policy involves buying government bonds on the open market to support an economy. The Fed expanded its balance sheet when interest rates were close to zero, and is now reducing its holdings to combat rapid inflation. The move will also impact the cost of major life events, such as weddings and college tuition.

While the Fed's large balance sheet can be harmful in some ways, it is not causing significant problems for the economy and market. According to a recent speech by Janet Yellen, the date for ending the reinvestment program is getting closer. The median dealer expects the balance sheet to shrink by $1.7 trillion in 2025. Eventually, the Fed will be forced to hike interest rates again.

It increases mortgage rates

Quantitative tightening is the policy of the Federal Reserve to reduce its balance sheet by buying long-term bonds and mortgage-backed securities. This policy aims to keep long-term rates low while encouraging productive use of capital. As of today, quantitative tightening has lowered bond yields, but this policy has not reversed its impact on the long-term rate. The Fed's research shows that the rate on 10-year treasury bonds has decreased by more than 50 basis points since December.

Although mortgage rates have been falling for several years now, the current rise in the federal funds target rate has caused mortgage interest rates to jump above their pre-recession levels. The federal funds target rate rose by 225 basis points between November 2015 and November 2018, causing mortgage interest rates to rise proportionately. This increase has made mortgages more expensive for consumers and could lead to more volatility in the housing market. However, this increase is not yet large enough to cause the housing market to collapse.

It brings down inflation

If the US economy is struggling and inflation is rising, the main tool the Fed has at its disposal to control it is interest rates. These rates are akin to the magic wands of Harry Potter, the heart-shaped herbs of Black Panther, and the square pants of Spongebob. Today, the Fed announced another interest rate hike. How does this affect the economy? We will discuss this topic in more detail.

One of the most obvious effects of quantitative tightening is to shrink the federal government's balance sheet. During the bubble years, the Fed pumped trillions into the financial system through massive stimulus plans. As a result, banks had record reserves. However, quantitative tightening is designed to reduce this excess liquidity, and therefore reduce inflation. As the Fed begins to reduce its $9 trillion balance sheet, it will cause mortgage bonds and Treasuries to seek a home in the private sector. As a result, the number of reserves held by banks will decrease.