Underestimated effects of the termination of QE and forward guidance

October 25, 2014

It is evident that non-conventional Fed policy has contributed to long-term yield compression. It is less evident how this exactly worked and what will happen when the Fed tries to terminate QE and forward guidance. A new IMF paper supports evidence for two underestimated effects. First, to maintain existing stimulus the Fed must constantly announce new asset purchases or holding period extensions. Second, the stimulus from asset purchases depends on forward rate guidance and hence may decrease when the latter ceases.

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How Fed asset purchases reduce yield term premia

February 15, 2014

An updated Federal Reserve paper suggests that there has long been a link between the net supply of government securities and term premia on Treasury yields. A 1%-point reduction in the ratio of Treasuries or MBS (10-year equivalent) to GDP supposedly reduced the 10-year term premium by 10 basis points. A one-year shortening of the average effective duration would lower the ten-year Treasury yield by about 7 basis points. Based on these estimates, the 2008-2011 large scale asset purchase and maturity extension programs of the Federal Reserve could have reduced the 10-year term premium by a total of 150 basis points.

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Unconventional monetary policy: impact and exit problems

October 15, 2013

According to a new IMF report, unconventional monetary policies succeeded in stabilizing financial markets and lowering sovereign yields. Since protracted accommodation would invite excessive duration risk taking, the design of exit is becoming more important. Tightening may occur first through forward guidance or even rate hikes, before the vast outstanding excess reserves can be reduced back towards pre-crisis levels. This could imply greater volatility of interest rates, due to limited control of central banks over short rates and great uncertainty about the impact of tapered and reversed purchase programs on long–term yields.

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Quantitative easing and the collateral problem

September 2, 2013

Another (IMF) paper of Manmohan Singh deals with the influence of non-conventional monetary policy on collateralized borrowing. In past years, quantitative easing (QE) has absorbed collateral from private funding markets and, thereby, reduced private repurchase (collateral) rates relative to policy rates. An unwinding of central bank balance sheets in the future could increase the spread between policy and collateral rates – if the collateral finds its way on bank balance sheets – or reduce the degree of financial “lubrication” – if it ends up with non-banks. Put differently, in a large-scale QE unwind central banks could temporarily lose  control over lending conditions.

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Risks related to the Fed’s exit from ultra-easy policy

July 28, 2013

The IMF Article IV consultations for the U.S. suggest that a Federal Reserve exit from unconventional and highly accommodative policy may be challenging. Most importantly, quantitative estimates and past experiences indicate that the term premium on long-dated bond yields can vary greatly and become disruptive for markets and the economy. Meanwhile, the envisaged “passive” rundown of large treasury and MBS holdings would take a long time to unwind the Fed’s bloated and more risky balance sheet. And as long as excess reserves are ample even the Fed’s control over short-term rates will be imperfect.

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U.S. Fed “tapering”: The basics in the FOMC’s own words

July 1, 2013

Envisaged Fed tapering is simply predicated on five principles: (a) balance sheet expansion will slow and ultimately cease if unemployment declines on a sustained basis to around 7%, (b) the pace of asset purchases remains data dependent, hinging on sustained labor market improvement and financial conditions, (c) tapering is not meant to tighten monetary conditions, (d) tapering does not per se lead to subsequent unwinding of Treasury holdings and may never result in MBS sales, and (e) tapering does not per se bring forward Fed fund rate hikes, which are subject to higher thresholds.

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What we can learn from Asia’s “tapering”

June 30, 2013

J.P. Morgan’s David Fernandez points out that central bank “tapering” (moderation of balance sheet expansion and related monetary accommodation, currently envisaged by the U.S. Federal reserve) has a precedent of sorts. Emerging Asia had ramped up central bank assets for a decade after the 1997-98 crisis, mainly though FX interventions to bolster financial stability and competitiveness. Asia has been unwinding part of that expansion, passively and in line with smaller external surpluses, since 2008. The initial balance sheet expansion did not undermine credibility and price stability. And the subsequent reduction may be interpreted as a positive normalization, reducing the risk of financial bubbles.

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The effectiveness of non-conventional monetary policy

May 18, 2013

The latest IMF publications on non-conventional monetary policies affirm their effectiveness. This seems to hold true for all major forms, i.e. government bond purchases, forward guidance, and private asset purchases. However, bond purchases are likely to yield diminishing effects going forward. Their initial stimulus seems to owe much to the signalling of commitment and the repair of broken markets. Also, the economic impact seems to have a time limit. Meanwhile additional credible yield compression becomes ever more difficult as the zero boundary is drawing closer and central banks would struggle to extend commitments to ever longer durations.

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The impact of non-conventional monetary policy on financial markets

April 19, 2013

The April 2013 IMF Global Financial Stability Report takes stock of the market impact of non-conventional central bank policies. In particular, the latter have replaced traditional interbank and money market activity, turned the Fed into a dominant player in the U.S. MBS market, and made all G4 centrals banks (and particularly the Bank of England) a major holder of local government debt. The politically mandated biases in market prices could unwind disorderly if and when economic development mandates a reversal of non-conventional policies.

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