Many will say that we have quantitative tightening (QT) now, not QE

Just recently, we’ve seen both the BIS and the Fed release reports that foresee dangers, especially for emerging markets, from the sharp rise in G10 policy rates. On the surface such concerns seem to make perfect sense. But these sorts of warnings about the impact of sharply higher policy rates seem similar to those that suggest the US economy will fall into recession, because the yield curve has inverted, or that negative annual money supply growth in major countries heralds deep economic downturns.

Another warning we’ve had within the developed markets is that surging policy rates will cause all sorts of skeletons to fall out of the closet, such as strains among non-bank financial institutions. But so far, at least, none of these doomsday warnings have proved correct. Of course, there has been the odd wobble, such as US regional bank strains back in March, or the UK’s pension crisis last September. But they have been limit  ed and seemingly quickly mopped up by more central bank support from the likes of the Fed and BoE.

And in emerging markets as well, there have undoubtedly been some strains but we would argue that there’s not been the bloodbath that many might have anticipated in light of the surge in policy rates, particularly from the Fed. Of course, it might be early days yet but there must be a reason why these very adverse predictions have not proved correct.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said that the main reason why the negative forecasts have not proved accurate is that they have failed to take into account the regime change that is QE. For a start, making historical comparisons, as the Fed and BIS do in these papers, is meaningless as there’s never been a period in which central bank balance sheets have been inflated in this way.

“If we take US yield curve inversion, for instance, the curve between 10-year yields and the fed funds rate has been inverted by as much as around 160-bps this year. That’s a lot in historical terms but the history does not take account of the fact that the Fed’s QE has arguably caused 10-year yields to be at least 160-bps lower than would have been the case in the absence of such support”, said Mr. Steve Barrow.

In other words, there’s been no real inversion if you measure the curve on a ‘like-for-like’ basis with what we have seen before. Of course, many will say that we have quantitative tightening (QT) now, not QE. But in Mr. Steve Barrow’s view, there are two points here.

The first is that QE is a stock concept, not a flow concept. In other words, what is important is that the Fed’s assets are materially larger than required; not that they are being reduced by around USD90bn per month via QT.

The second point is that it is bank reserves that are crucial to the lending environment, not Fed assets and, while assets have come down, reserves have not. On the money supply, yes, it’s very unusual to see declines in annual monetary growth if you go back in history. But no period in history has seen QE like this which is replenishing the liquidity that might be draining away thanks to falling monetary growth.

“We could go on but the point is that historical comparisons are pretty useless and hence we should not necessarily be surprised that the international spillovers from the sharp rise in G10 policy rates are not as bad as we might have feared. Of course, this could change, but we suspect that it won’t for, as we’ve said many times before, history is a good guide to the past”, said Mr. Steve Barrow.