Quantitative Tightening – The End of Easy Money

market analysis

By

Paul Ashworth, Managing Partner
David Clark, Director
Antony James, Analyst


Posted 25 January 19

Quantitative easing and falling interest rates have been universally good for the holders of capital and investors. The reversal of this process is unlikely to be beneficial for investors and holds the potential to unwind the windfalls that investors have received through re-rating.

The last ten years have been notable for the unconventional monetary policy that has been employed by central banks around the globe.

Headline interest rates have dropped to historic lows, including the adoption of negative rates in a handful of countries. When this wasn’t enough to stoke demand, bankers purchased bonds to reduce long-term borrowing rates in a process dubbed Quantitative Easing (QE). The outcome was a flight of capital to existing assets (shares/property) that drove up valuations, suppressed income for savers (retirees) and did little to kickstart the economy.

Central banks must now embark on the journey towards rate neutralisations. The US is furthest along this path, through a combination of rate increases – nine thus far – and Quantitative Tightening (QT).

QT is the inverse of QE. Through this process, the Fed is allowing the $2.5b in securities on its balance sheet to mature without reissuance. The impact is a reduction in the money supply and the likely increase in long-term interest rates.

Real Fed Fund Rate

Diagram showing Real Fed Fund Rate

Why Are Rates of Greater Importance Now?

With US rates now at 2.25%-2.5%, we are very near to the neutral rate – a hypothetical rate where monetary policy neither stimulates or restrains the economy.

To this point in time, monetary conditions have tightened, but rates have been below the neutral rate, thus providing further stimulation to the economy, albeit at a lower level.

This is set to change in 2019, with the combination of higher Fed rates and reducing money supply (Quantitative Tightening) now a drag on the world's largest economy.

The key risk is that central banks are in uncharted waters. Never have they attempted QT, and history shows the Fed usually tightens by too much or too quickly for the US economy. As we move towards, and potentially through the neutral rate, the risk of recession is heightened.

Economic and Investment Strategy

As partners in your investment journey, it is important to us that we take the time to share key aspects of our approach and philosophy.

This article is part of our 2019 Economic and Investment Strategy Guide and one such starting point in our highly considered process that will ultimately manage downside risk and maintain the real value of capital.

For further reading of our 2019 Economic and Investment Strategy, please click one of the links below:
Government Intervention – First Right then Left
Slowing Global Growth – Diverging Fortunes
Debt Hangover – Credit Tap Turns Off

For more information on our approach to economic strategy or to obtain your own copy of our 2019 Economic & Investment Strategy Guide, please contact us on +613 9655 5000.