President Donald Trump has railed repeatedly about the Federal Reserve’s “quantitative tightening” and the impact it has had on economic growth during his administration. The program will be over soon, which may not bring as much relief as Trump thinks.
One reason the president may not want to get his hopes up too much is that he may be overstating its impact.
The program does not, as Trump suggested a few days ago, pull $50 billion a month out of the economy. In fact, there’s an argument to be made that conditions haven’t tightened much or at all since the QT program began in October 2017.
At its core, the moniker references the Fed’s decision to start reversing the stimulus it provided during and after the financial crisis that exploded in 2008. The Fed instituted three rounds of bond buying that exploded its balance sheet from around $800 billion to more than $4.5 trillion at one point. The idea, called quantitative easing, was to knock down long-term interest rates to resuscitate the housing market and to provide needed liquidity for the financial system.
In mid-2017, central bank officials decided the economy was strong enough that it could reduce some of its holdings. It would do so by allowing a capped level of proceeds from all those bonds it was holding to roll off the balance sheet each month, rather than reinvesting them as had been the policy.
The caps started small at $10 billion a month — $6 billion in Treasurys and $4 billion in MBS — then increased quarterly to $50 billion.
But those were simply maximums. In reality, the rolloff hasn’t hit $50 billion a month because the proceeds from the maturing bonds haven’t amounted to that much. Trump told ABC recently that the process “is taking money out of the tills so that people can’t use it for doing what they’re doing.”
The money, though, isn’t coming out of any tills but simply is from bond proceeds held at the Fed that are not being pumped back into the system. And it’s not $50 billion a month. In the May 23-June 27 period, for instance, the reduction in the two items was just $36 billion, or just less than 1% of the total holdings and less than 0.2% of the total U.S. economy.
Then there’s the issue of tightening financial conditions. By a number of metrics, the current situation is just about the same as it was back when the balance sheet reduction began in October 2017.
For one thing, bond yields, after a brief surge in the fourth-quarter of 2018 amid worries about excessive Fed rate hikes, are basically back where they were when the reduction began. The benchmark 10-year note yielded around 2% Friday, fractionally below where it sat before the Fed roll-off.
Looked at from another angle, The Chicago Fed’s National Financial Conditions Index, which examines risk, credit and leverage, is actually lower now, at -0.85, than the 0.79 reading where it was on Sept. 29, 2017, before the QT exercise began. (Lower numbers represent easier conditions.)
Goldman Sachs also has a similar index that looks at interest rates, credit spreads, the overnight funds rate and other metrics and is closely followed by Fed officials. The Goldman US Financial Conditions Index also reflects conditions that if anything have gotten somewhat easier during the balance sheet reduction.
Even so, Trump contends that without the Fed doing quantitative tightening and rate hiking, the economy and markets would be much better off. (He also incorrectly told Fox Business that the Fed hiked rates nine times during his administration and none during Barack Obama’s, which is also incorrect. The Fed hikes twice near the end of Obama’s second term and seven times under Trump.)
Trump has said several times that the Dow Jones Industrial Average, which has performed strongly since Trump’s election in 2016, would be 10,000 points higher had there been no QT. He also told Fox that he thinks GDP growth would be close to 5% rather than the 2.9% seen in 2018 and a slower pace that is expected this year.
Trump likely will soon get his wish to see how his economy will perform without the Fed tapping on the brakes.
He’s already had one demand granted — the Fed has backed off plans to hike interest rates twice this year and now is expected to cut up to three times. A second gift is on the way: The Fed already has announced plans to end the balance sheet reduction in September.
But some on Wall Street think that instead of implementing a widely expected rate cut at the July 30-31 Federal Open Market Committee, officials instead will vote to end the balance sheet rolloff even sooner than announced with an immediate halt rather than waiting until September.
In any event, at a time when businesses are widely citing Trump’s tariffs as a reason for an expected deceleration in economic activity, the president will soon get to see how strong growth is without the Fed standing in its way.