The Economist - UK (2022-04-09)

The Economist April 9th 2022 Finance&economics 65

HousinginAmerica

FOMOfroth

I

vyzelmanknowsa thingortwoabout

theAmericanhousingmarket.Shewas

rareamongmainstreamanalystsinwarn­

ingoftroublein2005,ayearbeforethe

bubblestartedtoburst.In2012,whenma­

nyinvestorswerereluctanttogetbackinto

property,shedeclaredthesectorhadhit

rock­bottom;priceshavemorethandou­

bledsincethen.Soit isworthpayingatten­

tiontoherlatestpronouncements.“It’seu­

phoricrightnow,”shesays.“Therearedefi­

nitesignsofexcess.”

ButMsZelman,whohasgonefromin­

WASHINGTON,DC

Thepropertymarketisonceagain

lookingbubbly

Limited stocks only

United States

Sources:FreddieMac;FederalReserve

BankofSt.Louis;Realtor.com

8

6

4

2

0

22201816141210082006

Average30-yearfixedmortgagerate,%

90

60

30

0

DNOSAJJMAMFJ

Property listings, median

number of days on market

0

2021

2020

2017-1 average

TheFederalReserve

Goodbye, QE.

Hello, QT

Q

uantitative easing, orqe, once an

unconventional tool of monetary poli­

cy, has become commonplace over the past

decade.  During  the  pandemic  alone  the

Federal  Reserve  bought  a  staggering

$3.3trn  in  Treasuries  and  $1.3trn  in  mort­

gage­backed securities as it sought to keep

borrowing  costs  low.  The  reverse  process,

quantitative tightening (qt), when central

banks  shrink  their  balance­sheets,  has

been  far  rarer.  The  Fed  is  the  only  central

bank to have truly attempted it, and it had

to stop abruptly in 2019 because of market

ructions.  So  its  plan  for  reducing  its  as­

sets—trailed in the minutes of its meeting

in March, published on April 6th—takes it

into relatively uncharted territory.

Officials  like  to  downplay  the  signifi­

cance of qt. When at the Fed’s helm, Janet

Yellen  compared  it  to  watching  paint  dry.

Jerome  Powell,  her  successor,  says  it  will

operate  in  the  background.  In  truth  it  is

akin to dismantling an auxiliary engine for

the economy, with only hazy knowledge of

the consequences.

As Lael Brainard, a member of the Fed’s

board, noted on April 5th, this round of qt

will be more aggressive than the Fed’s pre­

vious  iteration.  With  inflation  racing

aheadand the labour market tight, the cen­

tral bank wants to cool the economy quick­

ly.  Coupled  with  interest­rate  rises,  qtis

likely to be a drag on growth.

So  far  the  Fed  has  reinvested  the  pro­

ceeds of maturing bonds in order to main­

tain  its  stock  of  assets.  The  minutes  sug­

gest it is likely to shrink its balance­sheet

not  by  making  active  sales,  but  by  letting

some  maturing  bonds  “roll  off”,  without

reinvestment.  The  roll­off  may  start  in

May. Come July, all going well, the Fed will

raise  the  maximum  roll­off  to  $95bn  per

month, split between $60bn of Treasuries

and  $35bn  of  mortgage­backed  bonds.  At

full  tilt,  the  Fed  could  shrink  its  balance­

sheet  by  more  than  $1trn  over  a  12­month

period,  twice  as  fast  as  its  first  go  at  qt.

“Even if it’s done in a predictable way, this

is a big adjustment for markets,” says Brian

Sack of D.E. Shaw, an investment firm. 

Multiple  rounds  of  bond­buying  by

central  banks  since  the  financial  crisis  of

2007­09 have yielded some understanding

of how qeworks. It signals a commitment

to  ultra­low  interest  rates.  It  suppresses

long­term rates. And it supports liquidity,

ensuring that markets operate smoothly. 

qtlooks  like  qein  reverse.  Instead  of

creating central­bank reserves (held by the

private  sector)  by  purchasing  bonds,  the

central  bank  drains  reserves  by  refraining

from  reinvesting  as  bonds  mature.  The

three channels through which qeworks al­

so operate in reverse. First, qtsends a sig­

nal  that  rate  rises  are  coming.  Notably,  it

was in early January, when the Fed discuss­

ed  a  faster  approach  to  qtthan  many  had

expected, that market rates shot up. 

The second channel—qt’s direct impact

on  yields—involves  heroic  guesstimates.

Some analysts think the Fed will shrink its

balance­sheet by $3trn over the next three

years (taking it to about 20% of gdp, down

from  36%  now).  Mark  Cabana  of  Bank  of

America reckons this could equate to any­

where  between  a  quarter  point  and  1.25

percentage  points  of  rate  increases—a  re­

markably  wide  range.  Mr  Powell  has  also

noted the uncertainty about qt: “We have a

much better sense, frankly, of how rate in­

creases affect financial conditions.”

When the Fed raises interest rates, it is

raising  overnight  borrowing  rates,  which

then ripple along the yield curve. With qt,

the main impact is on longer­term yields.

For  some  economists,  such  as  Kristin

Forbes  of  the  Massachusetts  Institute  of

Technology,  this  means  that  qt could  be

more potent than rate rises, since it would

target  hot  segments  of  the  credit  market,

such as mortgages (see next story). The Fed

has said that it will stick with rate increas­

es—the devil it knows—as its main tool. If,

however, qtdoes hit longer yields, it may

need fewer rate rises to tame inflation.

The final channel is liquidity. As the Fed

buys fewer bonds, there may be fewer tran­

sactions  overall.  Indeed,  a  Bloomberg  in­

dex that measures the ease of trading Trea­

suries recently worsened to levels last seen

at  the  pandemic’s  start.  That  echoes  un­

comfortably  with  the  past  round  of  qt,

which culminated in a liquidity crunch in

the  overnight­borrowing  market.  But  the

Fed  is  better  prepared  this  time.  There  is

much  more  cash  in  the  market  to  begin

with. And the Fed has set up an overnight­

lending facility, which should let banks get

funds  if  needed.  “The  risk  of  a  spike  in

rates  like  we  had  in  September  2019  is

much,  much  lower,”  says  Bill  Dudley,  for­

mer president of the New York Fed. 

Yet new concerns will emerge. The Fed’s

mortgage  bonds  have  long  tenors,  so  pas­

sive roll­offs would take decades. The cen­

tral  bank  may  have  to  make  active  sales,

which  it  wants  to  avoid.  Another  concern

is the Fed’s $326bn in short­term Treasury

bills. Some observers think it will roll them

off,  supercharging  qt;  others  fear  that

would stoke volatility. But the biggest wor­

ry is whether qt willwork as intended, tak­

ing heat out oftheeconomy without caus­

ing undue harm.n

WASHINGTON, DC

The Fed prepares a little-understood

policy tool