Opinion  

Markets Insight
Is QE returning by stealth?
While the Fed is reducing its bond-buying programme, it is still providing stimulus via other means

MICHAEL HOWELL

The very act of quantitative tightening creates systemic risks that demand more QE © FT montage: Bloomberg

Michael Howell 3 HOURS AGO

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The writer is managing director at Crossborder Capital and author of ‘Capital

Wars: The Rise of Global Liquidity’

It has been a bleak year for many investors. Global investors have lost $23tn of
wealth in housing and financial assets so far in 2022, according to my estimates.
That is equivalent to 22 per cent of global gross domestic product and
uncomfortably exceeds the lesser $18tn of losses suffered in the 2008 financial
crisis.

Hopefully though, next year will not be so bad for assets, because the cycle of
global liquidity is bottoming out. Part of my reasoning is that quantitative easing
programmes by central banks to support markets are impossible to reverse quickly
because the financial sector has become so dependent on easy liquidity. The very
act of quantitative tightening creates systemic risks that demand more QE. 

We track the fast-moving, global pool of liquidity — the volume of cash and credit
shifting around financial markets. The impact of the ebb and flow of this pool,
currently about $170bn, can be seen in the central bank programmes to support
markets through the Covid-19 pandemic — quantitative easing. The latter drove
another “everything up” bubble through 2020-21. But as soon as policymakers hit
the brakes in early 2022 and triggered a near-$10tn liquidity drop, asset markets
collapsed.

We focus on liquidity because the nature of our financial system has changed. The
markets no longer serve as pure capital-raising mechanisms. Rather they are
capital refinancing systems, largely dedicated to rolling over our staggering global
debts of well over $300tn. This puts a premium on understanding collective
balance sheet capacity to finance debt issues over analysis of the cost of capital.

We estimate that for every dollar raised in new finance, seven dollars of existing
debts need to be rolled each year. Re-financing crises hit us more and more
regularly. Hence, the importance of liquidity.

So, what now? According to our monitoring of liquidity data, we have just passed
the point of maximum tightness. The two most important central banks driving the
global liquidity cycle are the US Federal Reserve and the People’s Bank of China.
Think of the Fed as mainly controlling the tempo of financial markets, given the
dominance of the dollar, whereas China’s large economic footprint gives the PBoC
huge influence over the world business cycle. In short, the stock market’s price-
earnings multiple is determined in Washington and its earnings Beijing.

The Chinese market enjoyed a large jump in liquidity injections in November, led
by the start of an easier monetary policy from the PBoC. Contrary to the consensus
view, latest data also show the US Federal Reserve adding back liquidity into dollar
markets, despite its ongoing QT policy.

Admittedly, the Fed has reduced its holdings of US Treasuries in seven of the past
nine weeks as part of QT. But net liquidity provision, benchmarked by moves in the
Fed’s “effective” balance sheet, has remarkably risen in six of these weeks. In fact,
the Fed added an impressive $157bn to US money markets through its operations.

Looking ahead we project a further pick up in global liquidity China desperately

Looking ahead, we project a further pick-up in global liquidity. China desperately
needs to boost its lockdown-hit economy, so expect further policy stimulus in
2023. Two other favourable factors are the lower US dollar and weaker oil prices.

We estimate that each percentage point fall in the dollar increases the take-up of
cross-border loans and credit by a similar percentage amount. The US currency is
already down a hefty 9 per cent from its recent peak. The fall in oil prices to below
$80 a barrel should also help, reducing the amount of credit required to finance
transactions.

But there could be more. The US Fed plans to reduce its holdings of Treasury and
government agency securities by $95bn per month. But other items are likely to
offset some of, perhaps even, all of this.

First, the $450bn Treasury General Account, the US government’s deposit account
at the Fed, is likely to fall as bills are paid ahead of difficult upcoming debt ceiling
negotiations. Second, the Fed’s $2.52tn “reverse repo” facility for providing short-
term investment to parties such as money market funds could drop significantly.
This is because there are hints that the Treasury will issue more bills, debt of less
than one-year maturity, relative to bonds which have longer terms.

Third, rising interest rates mean the Fed will pay out more on debt it has issued.
This could amount to a whopping $200bn over 2023. 

The September turmoil in the UK gilt market was a reminder of the risks of
financial instability when liquidity is withdrawn. Mindful of such forces, could the
Fed be reluctant to push liquidity down too much? One could argue that by
winding back its portfolio of Treasuries (“official QT”), but allowing effective
liquidity provision to rise (“unofficial QE”), the Fed is trying to have its cake and
eat it!

Whichever, it surely shows that QT is harder to achieve in practice than in theory.

Stealth QE may be back next year and make what looks to be a difficult year feel a
tad better.

C i h Th Fi i l Ti Li i d 2022 All i h d
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