What's Quantitative Tightening? And Why Is It So Important to You?
Slowing down the economy? On purpose?!
Believe it or not, that’s the Fed’s goal right now.
The tool it’s using to do this is called Quantitative Tightening (QT).
Today, I’ll explain what QT is — and reveal what it means for investors like you.
For a transcript of this video, see below. This transcript has been lightly edited for length and clarity.
What’s Quantitative Tightening? And Why Is It So Important to You?
When Covid hit, the Federal Reserve sprung into action.
First of all, it printed trillions of new dollars to keep things rolling.
Second, it lowered short-term interest rates. This kept borrowing cheap and money flowing.
And third, it used its new money to buy long-term debt — in particular, mortgage securities. Why? Because this helped keep longer-term interest rates low, which is incredibly important to keep the economy moving.
You see, if the Fed is out there buying huge quantities of mortgage securities, the sellers of that debt don’t have to offer higher interest rates to attract buyers. This keeps rates low!
This third strategy has a name. It’s called Quantitative Easing.
Did it work? Well, sure. But maybe it worked too well. It created massive inflation, which is the root cause of all the pain we’re experiencing in the markets today.
So now the Fed is trying to run its printing presses in reverse.
This new strategy is Quantitative Tightening.
Let me explain more…
Shifting into Reverse
Quantitative tightening is a way to decrease the supply of money in the economy.
The way the Fed goes about this strategy is simple:
It slows down its purchases of all those mortgage securities I mentioned earlier.
A couple of days ago, on the first of the month, it started reducing its balance sheet by $47.5 billion per month. That’ll be the target amount for three months.
After that, the figure will rise to $95 billion a month.
And by the end of 2023, the total amount could reach $1.5 trillion.
The result of all this tightening?
Well, theoretically at least, borrowing will become more expensive…
The economy will slow down.
And inflation will slow down.
Then it can stop raising rates and the market can start rallying again.
Risk of Recession
But the market is freaking out right now about the Fed’s action.
In fact, it looks like the market is expecting the Fed to create a recession.
How do I know this?
Well, during “normal” times, the interest rate on short-term debt is lower than the rate on longer-term debt. Makes sense, right? Longer-term investors want to be compensated for the risk of inflation in the future.
But if the market is worried about a recession, things get inverted. Basically, the interest rate of short-term debt gets higher than the rate for longer-term debt.
Basically, the market believes the Fed will have to cut rates in the future so it can rekindle growth during a recession.
To see what I mean, just take a look at this chart:
The black line represents the yield spread between two- and 10-year Treasury notes. And the blue line represents the spread between 3-month T-bills and 10-year notes.
Every time those lines dip below zero — i.e., an inversion — there’s been a recession.
That’s what the big grey vertical line represents.
And as you can, those lines, once again, briefly dipped below zero.
Outperforming the S&P by a Wide Margin
We’ll know more in the months ahead.
But for now, here’s my advice:
As the markets keep tumbling and erupting, look for ways to take advantage of this volatility.
One of my picks, for example, has been outperforming the S&P 500 over the past three months by a huge margin.
If you’re a “Pro” subscriber, check it out below.
In the meantime, Zatlin out. Talk to you soon.
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