Author: Matt Phillips / Source: New York Times
Anyone paying attention to financial markets in recent months knew that the Federal Reserve’s management of the economy was perhaps the single most important question on the minds of investors.
The Fed, of course, has been raising interest rates, including four increases last year, which unnerved many investors.
These days, though, the focus has shifted to what the central bank will do with another tool it previously used to stoke economic growth.As part of its campaign to rescue the economy after the 2008 financial crisis, the Fed bought enormous quantities of bonds issued or guaranteed by the federal government. Now the question is how quickly, and by how much, it will shrink that pile.
On Wednesday, the Fed left rates unchanged and signaled that it could slow its bond sales if economic and financial conditions change. Investors cheered, with the S&P 500 rising about 1.5 percent. The index is up nearly 7 percent this year.
Once an area of interest for only the most intrepid of Fed watchers, the bond portfolio has started to overshadow more fundamental economic concerns, like China’s slowing economy and the government shutdown. Since last year, the Fed has been reducing its bond stockpile by up to $50 billion a month.
Investors increasingly point to the trend to explain the ugly performances of virtually every kind of investment in 2018. Even President Trump weighed in, tweeting in December that the Fed should “Stop with the 50 B’s.”
Players in the markets have bestowed the Fed’s bond-shedding policy with its very own nickname: quantitative tightening, or Q.T.
So what is quantitative tightening? How is it supposed to work? And how much of an impact is it having on markets? Read on.
Before there was Q.T., there was Q.E.
The first thing to know is that quantitative tightening is basically the slow unwinding of a series of policies put in place to counter the financial crisis.
A decade ago, that crisis nearly pushed the United States into a second Great Depression. Financial markets crashed. Unemployment surged. Economic growth collapsed.
By law, the Fed is supposed to fight unemployment. So, when recession rears its head, the central bank steps in, typically by cutting the short-term interest rates it controls. By the end of 2008, it had slashed them essentially to zero.
During normal times, short-term interest rates have a strong influence on how much it costs consumers and companies to borrow money. But during the financial crisis, the Fed’s rate cuts barely budged longer-term borrowing rates, which stayed stubbornly high. Investors were so spooked that they refused to put their money into anything other than super-safe, short-term government bonds.
The Fed needed to push longer-term interest…
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