US Fed Policy: Fed Pivot Raises Investor Question: When Does QT Begin?
Investors are asking a key question after the US Federal Reserve ramped up its reduction in bond purchases and unveiled more aggressive rate hike projections: When could the central bank finally start shrinking its massive balance sheet?
Bond investors had largely absorbed the Fed’s pivot to a more hawkish stance on inflation. The move to a faster reduction in new bond purchases from $ 120 billion per month to zero had been well telegraphed, as were the new forecasts from policymakers who have now convinced the market that the first interest rate hike will arrive no later than May, with more to follow by the end of the year.
But an open question is when the Fed could move from cutting bond purchases to reducing the central bank’s balance sheet.
After its reduction in 2014, the Fed kept its balance sheet essentially stable for about three years and eventually began to reduce its holdings from 2018 by allowing certain bonds to “drain” the portfolio without reinvesting capital back. ‘deadline, a process that has come to be known as “quantitative tightening” or “QT”.
“Now that quantitative easing ends faster and the first hikes in policy rates loom on the horizon, the ‘subject of the greatest dismay’ will turn to the potential for balance sheet runoff,” said Rick Rieder , BlackRock’s chief investment officer of Global Fixed Income in a research note.
Still, Rieder believes it would be “weak to start the runoff in 2022,” with the consensus among market players that this wouldn’t happen until 2024.
Collin Martin, a fixed income strategist at the Schwab Center for Financial Research, said he was careful when the Fed’s balance sheet runoff could begin, as risk rate hikes could flatten the curve further. yields or even reverse it if long-term rates don’t. to augment. An inverted yield curve can be the harbinger of a recession.
“If they start letting the bonds mature and they don’t pick up the pace of their buying, that means someone else has to do it,” he said. This could lead to lower demand and higher long-term yields, preventing the yield curve from flattening too quickly.
TD analysts wrote in a research note that they expect QT to begin in March 2023.
At the Fed press conference, Powell said policymakers “have not made any decisions about when the second round begins”, but “these are exactly the decisions we will look to in future meetings.”
Reaction to the Fed’s pivot was mixed, with stocks reversing past losses and ending up sharply higher, while US Treasury yields rose in choppy trading and the US dollar ended up falling.
Fund managers generally welcomed the Fed’s message to reverse an ultra-accommodative monetary policy.
“The Fed recognizes that the economy is very hot right now and needs to move out of the current framework,” said Steve Bartolini, portfolio manager for the US Core Bond strategy at T Rowe Price, who said he focused on assets such as bank loans that will benefit from a tightening cycle.
Still, investors saw the volatility to come. The ICE Bank of America MOVE Index, a measure of volatility expectations in the bond market, remains close to its highest levels since April 2020.
“The one piece I’m confident in as we try to pull ourselves out of this huge amount of stimulus is that volatility will remain high,” said Lon Erickson, portfolio manager at Thornburg Investment Management. “We will stay … conservative, keep this powder and be ready for the opportunities this volatility presents us.”
Jason England, global bond portfolio manager at Janus Henderson Investors, agreed that the onset of such a tightening could create “friction in the fixed income markets.”
Still, investors said the Fed appeared to be successful in avoiding panic, unlike in 2013, when bond yields soared during the so-called “tantrum tap.”
“Nobody is talking about tightening things up significantly,” said Brian Nick, chief investment strategist at Nuveen. “And so it should always be a good environment for risk taking by investors.”