All things being equal, more buyers of bonds would lift the price higher and thus move the yield lower. This is ideal for a central bank attempting to lift asset prices to provide stability and encourage economic activity. But things are never equal—more on this later.
The opposite of QE is QT. In this case, the central bank is selling their bonds or allowing them to expire. If selling, another investor needs to have the capital to buy said bond, so they may sell another asset to raise money. This is removing liquidity. Letting a bond mature has the same impact as chances are the government that issued the bond has to refinance and issue a replacement bond, which has to be purchased by someone.
Note to reader: yes, this is oversimplified. QE can be immunized, it can be used to buy other assets, etc. But don’t want to get too far into the weeds of the mechanics. QE injects liquidity and QT removes it.
If everything else were static, QT would remove liquidity from the financial system. This would cause asset prices to fall, meaning equity and bonds prices would move lower (and bond yields higher). That is perfectly logical. But the markets are not static, and they actually are filled with a healthy portion of smart people. The start of QT is not news—it has been telegraphed and announced multiple times. Which means, dare we say, it’s priced in?
In fact, if you look at past rounds of QE, it was the announcement that moved markets and bond yields —often weeks or months before the actual commencement of bond purchases. And when those actual bond transactions started, the market had often priced in the pending Fed action and, in most cases, had overreacted (i.e., gone too far).
The following charts pack a lot of information. Each one has the 10-year Treasury yield and S&P 500 during various QE programs. For QE1, 2 & 3, there is a vertical line when the announcement was made, a line when the actual QE commenced, and a line when it ended.
To varying degrees, bond yields tended to react lower to the announcement and then rise when the bond buying actually started. In each case, bond yields moved higher during QE, the opposite of what one would expect. Meanwhile, the equity market loves QE and rises during these periods. The QT chart for 2017 shows a limited reaction in yields and the market. This is encouraging.
The Covid QE chart at the bottom is a bit more complicated. The S&P 500 clearly rose on QE and peaked around the announcement of a pending QT. Interesting. However, there was still bond buying occurring, just at a declining pace as QT is just about getting started now. Still, it does appear that the announcement carried the punch and perhaps the actual quantitative tightening won’t have much impact.
The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.
This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.
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