The RBA Weapon That Will Raise Rates Further

In fact, the Fed and RBA and other central banks in the Anglosphere are pulling liquidity out of their systems and raising their interest rates. The Fed has raised its version of the RBA’s spot interest rate four times in five months — by a total of 2 percentage points — and the ECB by 50 basis points.

The RBA has raised the spot rate by 125 basis points so far this year and is expected to add another 50 basis points today to take it to a six-year high of 1.85 percent.

Since mid-2020, central banks, including Jerome Powell’s US Fed, have pumped about $12 trillion into the global financial system through the unconventional monetary policy developed by Japan in the early 2000s.Credit:Bloomberg

The effects of the QE programs are fairly well understood. Combined with zero or near zero policy rates, which affect short-term interest rates, they injected massive amounts of liquidity into the central bank’s financial systems and forced the interest on longer-term securities.

The lack of returns from traditionally safe assets, such as 10-year Treasury bonds, in turn forced investors to take on more risk—increasing risk, as it turned out—to chase positive returns. That was good for stocks and other risky assets like real estate.

It was especially good for the riskiest assets, such as crypto assets or technology stocks with good prospects but modest or no earnings.

For technology companies, that’s because the discount rate used to calculate the net present value for companies’ future cash flows is generally the 10-year bond yield. In the US, 10-year bond yields fell to around 50 basis points in mid-2020. It is now about 2.65 percent, last month as much as 3.25 percent.


Rising key rates and QT could be expected to largely undo those effects and to some extent have already begun to do so.

The start of the new interest rate cycle in the US has led to a savage sell-off in stocks and bonds (there is an inverse correlation between bond yields and bond prices) and a strengthening of the US dollar as investors return to the US Treasury market, albeit cash. money seems to be the preferred repository in what has been a volatile year thus far.

Try to figure out how much impact QT can have outside of the speed increases, but it’s problematic because there’s so little experience with QT.

Between October 2017 and September 2019, the Fed attempted to unwind some of its purchases in a program that peaked with a net contraction on its balance sheet of $50 billion a month.

There remains a lot of uncertainty about what QT processes will do to markets and economies.

There remains a lot of uncertainty about what QT processes will do to markets and economies.Credit:AP

However, when securities outflows accelerated to that level, markets rioted – the stock market collapsed and bond yields rose, forcing the Fed to back away and halt the program.

For investors, with their “Fed put” option safety net back in place, it was back to an environment with little need to assess or discount risk.

The Fed is now cutting its balance sheet by $47.5 billion a month. Starting in September, that rate will rise to $95 billion dollars a month.

In Australia, the RBA is depleting its wealth of government and semi-government bonds as they age. Because it mainly bought relatively short-term bonds – other central banks bought bonds with maturities of 20 to 30 years – the process to restore its balance sheet to a level it believes is more in line with financial conditions will be faster than that of the Fed. or the Bank of England.

Try to figure out how much impact QT can have outside of the speed increases, but it’s problematic because there’s so little experience with QT.

About $2 billion in bonds mature this month and the proceeds will not be reinvested. There’s another $2 billion in November and more than $13 billion in April, after which maturities through the end of the decade will average closer to $40 billion per year. The $188 billion term financing facility that provided the banks with unexpected gains will expire in June next year.

While there is uncertainty about QT’s potential impact on markets and economies, researchers at the Atlanta Fed have sought to link it to the effects of rate hikes.

They estimate that a $2.2 trillion passive roll-off of Treasury bills held by the Fed over a three-year period is equivalent to a 29 basis point increase in federal fund rates in “normal” times. During “turbulent” periods, this can be as high as 74 basis points.

That $2.2 trillion quoted by the Atlanta Fed will be reached by the end of next year, if the Fed sticks to its current portfolio-tightening plan — about half the time it takes the Atlanta Fed. research used. That could magnify the effects on rates and volatility.


Hopefully the central banks won’t blink like the Fed did in 2018. Since the global financial crisis, monetary policy has become increasingly unconventional and its effects have deliberately distorted risk pricing and the signals risk premiums send to investors and managers. They have corrupted and distorted the way markets have been.

QT may not be, as the former Fed chairman (and now US Treasury Secretary) once said, “something that will continue to play quietly in the background in a few years’ time” – it could add to the weight of rising policy rates on economies and volatility and liquidity do not match, but the era of ultra-cheap and ultra-available credit and the disruptions to financial institutions that QE has created must end.

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