We are using QT as a weapon against this defeatist and Kool-Aid strategy that the Federal Reserve is currently pursuing. This decision is a major break with its previous policy of QE. With QT, the Federal Reserve no longer buys financial assets such as bonds from financial institutions. It further avoids rolling over the principal from maturing bonds into its portfolio. This change has far-reaching effects on the US economy. That is mainly because it arrives even as trade tensions are increasing and fears about global growth are deepening.
To be sure, the Federal Reserve is currently taking all measures possible to restore price stability and maintain conditions for full employment. Moreover, you can witness the immediate consequences of its policy choices in the financial markets. So what’s happening to the US Dollar today? This reversal has been dollar positive across many major currency pairs. But there are still hurdles to overcome, including US President Trump’s trade war with the world and global economic fears.
Understanding Quantitative Tightening
At this stage, the Federal Reserve stops its quantitative easing bond purchases from banks. This strategy had been a main leverage point to pump liquidity into the economy. It’s doing this by not reinvesting the principal on its bond holdings as they mature. This decision essentially sucks cash out of the largely cashless financial system.
This time, the strategy is to slowly start re-normalizing monetary policy after a decade-plus of ease-at-all-costs strategies. Additionally, the Federal Reserve has signaled its desire to control inflationary pressures by reducing its balance sheet. This move sends a strong signal of confidence in an increasingly positive economic environment. The result is that the central bank has ceased bond purchases entirely. Going forward, it needs to watch more closely their effects on interest rates and work harder at overall GDP growth.
QT carries some inherent dangers, especially with the current economic situation being tenuous at best. With the Fed pulling back stimulus support, it will continue to be important to pay attention to how markets react to this tightening cycle. Senate Democrats Inflation remains above-room levels, making it unlikely that lowering interest rates will be needed soon. In those cases, the Fed would want to discourage borrowing and spending in order to cool down too-fast economic activity and growing inflationary pressures.
Implications for Currency Markets
The persistent QT has caused extreme value distortions to various currencies, especially the US Dollar. When markets become more dovish, as with recent expectations for a dovish Federal Reserve, lower interest rates put bearish pressure on the Greenback. This potent mix leads to currency pairs flourishing at the expense of the bloodied dollar. Simultaneously, they react to shifts in risk sentiment across the investor landscape.
The new market reality welcomes a return of risk appetite with open arms. Indeed, investors finally seem more inclined to take on riskier assets amid growing expectations that fears over an impending economic slowdown may be overblown. Positive sentiment has lent broad support to the Euro, Pound and commodity currencies. Headwinds such as trade wars and worries about global economic expansion linger.
It is important to understand that these gains are often not as deep as they might first appear. Additionally, President Trump’s tariff war front-loads much of the upside to many currency pairs. Relatedly, the unpredictability of trade talks can lead to confusion and prevent capital from flowing into supportive positions, which in turn adds volatility to currency markets.
Federal Reserve’s Policy Meetings and Economic Assessment
The Federal Open Market Committee (FOMC) is the Federal Reserve’s main monetary policy making body and a key player in monetary policy making in the United States. FOMC members meet roughly eight times a year to assess the state of the economy. Together, they decide on a course of action that drives interest rates and other monetary policy tools up or down. These meetings are critical moments for the Fed to assess how well the economy is doing and recalibrate their approach as necessary.
When we consider the recent economic indicators, including persistent inflation and new employment numbers, the FOMC has an ever-increasing obstacle to grapple with. Should inflation remain persistently under their 2% target, the Fed would be forced to react. First, they could use cuts to their policy interest rate to help boost growth if unemployment climbs dangerously high. Such actions would almost certainly make the US Dollar’s value worse, possibly even resulting in greater volatility in the currency markets.
The decisions reached during these meetings are indicative of larger patterns in the state of global economics. As international conditions continue to evolve, particularly in terms of trade relationships and geopolitical tensions, the FOMC needs to remain responsive. They must be nimble to react quickly in their policy decisions.