Money printing turns to money burning

The latest decision on interest rates from the Fed provided no comfort to markets – indeed, it supplied the impetus for the latest sell-off.


This was meant to be the year that the lengthy bond bull market finally turned into a full-blown bear market. And for much of the year, markets followed the script. Concerns about rising inflation and the Federal Reserve's gradual retreat from monetary stimulus saw bond yields rise steadily (and thus prices fall). Yet market jitters throughout the year have, in the past six weeks or so, metamorphosed into full-blown fear of a pending slowdown or even recession, sending bond yields down sharply. And the latest decision on interest rates from the Fed provided no comfort to markets indeed, it supplied the impetus for the latest sell-off.

Demise of the Greenspan put

Jerome Powell took over from Janet Yellen as chairman of the Fed on 5 February this year. That same day, the S&P 500 fell by 4% the worst one-day hit the US market had taken since 2011. Although the US market recovered to hit new highs later in the year, it was a clear sign of what was already troubling investors what would happen as monetary policy moved from being ultra-loose to a gradual tightening?

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Powell took over as the Fed was starting to reverse quantitative easing (printing money to buy government bonds). But that couldn't remain the case for good. And it fell to Powell to oversee the start of the reversal of quantitative easing (QE) or as it's become known, quantitative tightening (QT). Put simply, QE adds money to the market. The central bank prints cash and buys (mostly, although not exclusively) government bonds. In turn, the people who would have bought those bonds, or who owned those bonds, buy other assets instead.

QT is the opposite. The Fed takes cash out of the market by shrinking the quantity of government bonds it holds. When a bond matures and the Fed receives the cash, it simply destroys it rather than reinvesting the money in a fresh bond. The Fed is currently destroying around $50bn a month in this way, and in its final interest-rate setting meeting of the year last week, Powell confirmed that it plans to continue at that pace all through next year.

Advertisement - Article continues below

Longer-term perspective

This in turn is what has rattled markets. While investors had expected the Fed to raise interest rates (which it did, by 0.25 percentage points to a range of 2.25% to 2.5%), they had also hoped for a "dovish" message, given the recent slide in the stock market. Yet, while officials indicated there would be two rather than three interest rate hikes next year, the overall message was nowhere near as soothing as investors had hoped. Hence the "flight to safety" rally enjoyed by US Treasuries.

So what next? As the chart above shows, ten-year yields are still significantly higher than at the start of 2018. And given Donald Trump's tax cuts mean the US government will run a huge deficit next year about 4.7% of GDP which in turn means more government borrowing and a much larger supply of US Treasuries for investors to soak up, it would be logical to expect yields to rise in 2019. However, if fears of recession or over-tightening by the Fed grow, the appeal of so-called "risk-free" Treasuries may prevail.




How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Stock markets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019

Why Wall Street has got the US economy wrong again

The hiring slowdown does not signal recession for the US economy. Growth is just moving down a gear, says Brian Pellegrini.
25 Oct 2019
Stock markets

There are lots of reasons to be bearish – but you should stick with the bulls

There are plenty of reasons to be gloomy about the stockmarkets. But the trend remains up, says Dominic Frisby. And you don’t want to bet against the …
17 Jul 2019

Most Popular


Will coronavirus kill off the bull market?

It seems clear now the coronavirus will at some point go global. And when it does, will it bring down the stockmarket’s bull market? John Stepek looks…
27 Feb 2020

Gold, coronavirus, and the high cost of face masks in northern Italy

The price of gold is spiking – as it always does in a global panic. But this bull market predates the coronavirus epidemic, says Dominic Frisby, and w…
26 Feb 2020
Pension tax

Why it makes sense to scrap higher-rate pensions tax relief

The point of pensions tax relief is to keep you out of the means-tested benefits system. The current system is ridiculously generous, says Merryn Some…
24 Feb 2020

Why investors shouldn’t overlook Europe

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, tackles investor questions around Europe’s economic outlook and the conseq…
6 Nov 2019