It has been eight years since the Federal Reserve started its quantitative easing (QE) program of purchasing bonds to drive interest rates down and inject money into the economy. Since then, we have had QE2, QE3, and a host of QEs by other central banks around the world. The last round of quantitative easing ended in October 2014, and since then the Federal Reserve has kept its balance sheet steady by replacing maturing bonds. While many pundits predicted rampant inflation along with an economic boom from flooding the economy with money, neither happened. Heavily indebted borrowers didn’t borrow from banks, and lenders didn’t lend the money being injected into the economy. The extra money ended up sitting at the Federal Reserve in the form of excess bank reserves earning less than 0.50% until this year (the rate now stands at 1.25%).
Now the Federal Reserve is telegraphing its intent to take away the excess money created from quantitative easing, which could be called “quantitative tightening” or QT. By letting bonds on its balance sheet mature, the Fed will shrink its holdings over time. One of our own bond analysts, Dan Schniedwind, CFA, likens the Fed’s actions to “taking away lubricant to the financial system that it had been providing for the past eight years.” What is not known is how the markets will react to the reduced amount of lubricant. Given that other central banks are continuing their QE programs, the effect of our Federal Reserve’s QT on the markets may be muted. We are in uncharted waters, and the secondary and tertiary effects of QT are completely unknown.