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The Hot Topic in Markets right now: & # 39; Quantitative Stress & # 39;




Anyone who has noticed the financial market in recent months knew that the Federal Reserve's financial management was perhaps the most important issue of investor minds.

Of course, the Fed has increased the interest rate, including four increases last year, which is in the hands of many investors. Today, however, the focus has shifted to what the central bank will do with another tool that it previously used to stimulate economic growth.

As part of its campaign to save the economy after the 2008 financial crisis, the Fed bought huge amounts of bonds issued or guaranteed by the federal government. Now the question is how fast, and how much, it will shrink that pile.

On Wednesday, the Feds went unchanged and signaled that it could slow down bond sales if economic and economic conditions changed. Investors cheered, with S & P 500 increasing about 1.5 percent. The index is up almost 7 percent this year.

Once an area of ​​interest to only the most pristine Fed observers, the bond portfolio has begun to overshadow more fundamental economic concerns, such as China's slow economy and government closure. Since last year, the Fed has reduced its bond stock by up to $ 50 billion a month.

Investors are increasingly pointing to the trend to explain the ugly notions of almost any kind of investment in 2018. Even President Trump weighed in and tweeted in December that the Fed should "stop with 50 Bs".

Players in the Markets have given Fed's policy with their own nickname: quantitative tightening, or QT

So what is quantitative tightening? How should it work? And how much impact does it have on markets? Read on.

The first thing to know is that quantitative tightening is basically the slow winding down of a number of guidelines that have been put in place to counteract the financial crisis.

Ten years ago, that crisis pushed the US into another major depression. Financial markets crashed. Unemployment increased. Economic growth collapsed.

The Fed is required by law to combat unemployment. So when the recession reacts to the head, the central bank enters, usually by cutting the short-term interest rates it controls. By the end of 2008, it had turned them essentially to zero.

In normal times, short-term interest rates have a strong influence on how much it costs consumers and companies to borrow money. But in the financial crisis, Fed's interest rates had hardly budget long-term borrowing rates, which remained high. Investors were so spooked that they refused to put their money into anything but super-secure, short-term government bonds.

The Fed needed to push long-term interest rates down. With short-term prices at its lowest possible level, the central bank was looking for new tools.

And that's how quantitative relief was born.

At the beginning of 2009, the Fed began buying massive amounts of bonds – trying to raise prices and prices down. In 2014, the Fed was the proud owner of about $ 2.5 trillion worth of government bonds and more than $ 1.5 trillion of government bond bonds.

Yes.

Fed's bond acquisition was not immediately cured of all economic diseases that were caused by the recession. The United States would lag through nearly a decade of weak growth, even as the Fed continued to swallow bonds.

But consensus among investors and decision makers is that all bond purchases helped to push key borrowing rates, for example for 30-year fixed-rate loans and for corporate bonds, to their lowest level in a generation. It made loans at least a little less expensive and offered some support to the fragile economy.

In the stock market and bond market, the power of the Fed's campaign was even more pronounced. By pumping trillions of dollars into the financial system, quantitative easing increased the value of stocks, bonds and all other assets. Few in the markets find it a coincidence that the beginning of Q.E. was also the beginning of the longest beef market in history.

A decade later, the economy is in much better shape. Unemployment is at its lowest level for decades. Early data indicate that last year's economy grew at its fastest rate since 2005. Wages are starting to increase.

To the central bank, the rose-billed economic sign meant that it was time to start removing some of the scaffoldings it had erected to support the crumbling economy. The Fed began raising interest rates in December 2015.

And it has also begun to shrink its full of bonds. Last year, the Fed's portfolio was reduced by over $ 350 billion – the strongest reduction since the crisis.

You may also have noticed that the financial markets were beaten last year. Almost all types of investment seemed to suffer the same defective return.

S & P 500 was down 6.2 percent. High-quality corporate bonds fell 6.4 percent. US government bonds yielded a weak 0.9 percent return. A fall in crude oil prices sent goods down 15 percent. In fact, for the first time in decades, almost all major classes of investment were in sync, with no more than 5 percent draft.

Concern over Q.T. flared in December. As the stock markets fluctuated wildly, Jerome H. Powell, the Fed leader, played the chance that the central bank would change its approach to its steady bond reductions, which he described as "automatic pilot". The stock market sank about 6 percent in the days following the statement.

Fed's shrinking bond portfolio is not completely blamed for the carnage in 2018. Many other things were worried by investors: a slowdown in global growth, a weakening of corporate profits, the trade war with China, and Fed's rate hikes. 19659002] Economists inside and outside the Fed say last year's impact should have been relatively small. After all, the gradual, repeated bond reductions began many years ago, and should have been included in the financial markets.

Nevertheless, investors wanted the Fed's message on Wednesday that it could change their plans to reduce their bond holdings. The central bank said in a press release that it was "prepared to adjust some of the details to complete the normalization of balances in the light of economic and financial developments." At a press conference, Mr. Powell also suggested that the decline in Fed's bond positions could stop faster and leave the Fed with a larger supply of bonds than previously thought.

"Any conversation about the balance that does not use the word autopilot is good," said Scott Wren, senior global equity strategist at Wells Fargo Investment Institute.



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