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Market players are starting to fear a major policy mistake by the central bank

Screens show the Fed rate announcement as traders are at work (in the post) on the floor of the New York Stock Exchange (NYSE) in New York on June 15, 2022.

Brendan McDiarmid | Reuters

The US Federal Reserve struck a hawkish tone last week about fighting inflation through monetary policy, but analysts are concerned about the potential threat of its sustained tightening strategy.

Federal Reserve Chairman Jerome Powell has warned that the US economy will face “some pain” as the central bank continues to raise interest rates aggressively.

Markets around the world have fallen amid clear confirmation that monetary policy tightening is being front-loaded, and a recession is on the horizon as policymakers look to the Fed’s funding rate as a key inflation-fighting tool. risk may be exacerbated.

But in a research note on Tuesday, analysts at London-based Crossborder Capital said the “quantitative liquidity dimension” was overlooked, suggesting that the Fed’s balance sheet contraction or quantitative tightening would be asymmetrical to the economy. claimed to have had an impact.

“The Fed sees QT/QE acting like an ‘air conditioning unit’ humming in the background, but QT is a ‘air conditioning unit’ humming in the background,” Chief Executive Michael Howell said in a memo. It’s seen as a wrecking ball that eventually reverses into another QE.

Ahead of Powell’s Jackson Hole speech, CrossBorder said the Fed’s course of action raised the risk of “significant future policy errors”, particularly “the impact of excessive QT on financial stability”. warned.

quantitative tightening

Quantitative tightening is a monetary policy tactic used by central banks to reduce liquidity and shrink their balance sheets, usually by selling government bonds or decoupling them from bank cash balances as they mature. will be split.

Cross-Border Capital believes central banks are sucking too much liquidity out of financial markets too quickly, and Howell said the recent hawkish move by some European Central Bank policymakers Pointing to the shift, he said this could lead to destabilization of the euro and eventually a liquidity pivot from central banks in 2023.

“Our concern is that QE/QE will have too much of an impact on financial stability, and the proposed shrinking of the Fed’s balance sheet by about one-third would be equates to about 5 percent points added to ,” Howell said.

“At some point in 2023, the Fed will have to turn to improve its balance sheet again and weaken the US dollar. will strengthen further, which should surprise the market.”

Concerns about QT are echoed by Mothers chief economist George Lagarius, who told traders and investors to forget what he heard from Mr. Powell at Jackson Hole and instead use the Fed’s assets as the single leading indicator. encouraged to pay attention to

Forget Powell's Jackson Hole speech, strategist says 'absolutely no one' knows what's next

The Federal Reserve (Fed) has raised the quantitative tightening cap from $45 billion to $95 billion. Meanwhile, the ECB, which he will end quantitative easing in September, has a program in place to limit the fragmentation of borrowing rates between more indebted and less indebted member countries.

“will [the Fed’s cap increase] Suck money out of the market at a fast pace? The real intention will be shown in that field, not in policy speech,” Lagarias said Tuesday.

“On the one hand, investors should worry about the long-term implications of the Fed’s stance. A slowdown could lead to a deep recession. Inflation could turn into deflation.”

He said emerging market and U.S. exporters are already suffering from a strong dollar, while consumers are struggling, especially in the current environment, where central banks are pushing policies toward lower wages to cut the cost of living. , pointed out that they were “at the end of their own leash.” crisis.

“It may not be long before the independence of central banks is called into question,” speculated Lagarias.

Are you underestimating the impact of QT?

When the Fed trimmed its bond portfolio in 2018, it led to the infamous “taper tantrum” (a plunge in the market) that prompted the central bank to ease policy and slow the pace of Treasury sales.

Gary White, chief investment commentator at British Investment Manager, said: “Central banks have ample reserves and central banks don’t need to hold so much government bond issuance. They argue that they can afford to reduce their bond holdings.” Charles Stanley said in a note prior to Powell’s Jackson Hole speech.

“Much of it could be held by the private sector at the expense of bank deposits. Central banks may be underestimating the impact of a significant quantitative tightening.”

BNY Mellon's AJ Oden says markets aren't pricing in the impact of quantitative tightening

The government aims to sell a significant amount of debt over the next few years as fiscal policy has loosened unprecedentedly in light of the Covid-19 pandemic in early 2020.

White suggested that the central bank’s end to bond purchases means the government will have to pay higher interest rates to relieve its debt.

“If central banks turn to sellers of government bonds, it will become more difficult,” he said.

“For the time being, the Fed’s and ECB’s primary objective is to halt all new bond purchases and allow portfolio run-offs as the government must repay the bond debt at maturity.”

Beat Wittmann, chairman and partner of Zurich-based Porta Advisors, also recently warned of a growing risk of a “serious financial disaster” that could trigger a market decline later in the year.

“The list of weak link candidates is rather long and includes the zombie-shaped European universal bank, LBO [leveraged buyout] It has funded companies, over-leveraged shadow-banking players, and over-indebted emerging market sovereigns,” Wittman said.

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