FROM QUANTITATIVE EASING TO QUANTITATIVE TIGHTENING?

02.02.2022 As inflation rates have risen around the world central banks have reduced the amount of Quantitative Easing they have conducted. However, there is now talk about a move to Quantitative Tightening. What exactly is Quantitative Tightening and what effect will it have on the markets?

Quantitative Easing is the act of central banks pumping money into the economy by buying financial assets with newly created electronic money. By contrast Quantitative Tightening is the act of cancelling some of this electronically created money. This is often achieved by not reinvesting the money when financial assets, owned by the central bank, mature.

Financial markets were taken by surprise when the US central bank minutes of its December meeting suggested that as well as interest rate rises this year it was also discussing Quantitative Tightening (see above for definition). The last time the US central bank began raising interest rates (2015) it was two years before it commenced Quantitative Tightening (2017). With USD 9 trillion of assets on its balance sheet now, compared to USD 4.2 trillion in 2017, Quantitative Tightening may also be faster than in 2017.  So, if Quantitative Easing ends in March, with interest rate rises starting soon after, Quantitative Tightening might be expected to begin in the second half of 2022.

The reason this is important for financial markets is two-fold. An important side effect of Quantitative Easing is that all the extra money created tends to push up asset prices. For example, in 2021 US house prices rose around 20 percent and the S & P 500 27 percent.  In contrast Quantitative Tightening tends to put downward pressure on asset prices. Additionally, as the US central bank is the most powerful central bank in the world its activities set the tone for global financial markets.  So, the prospect of US central bank interest rises and quantitative tightening suggests 2022 is likely to be year when equity markets correct. However, as the year wears on, we expect this to create some good buying opportunities for long term investors.

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This post was written by Robin