No end in sight for the semiconductor revolution
January 30, 2019
American Funds video transcript: “Fed’s move from QE to QT is fueling income, volatility”
Will McKenna: Mike, as a bond guy, I know you also look at the big-picture, macro issues of the day. Talk to us about the big macro realities, as you call them, and how they're affecting bond markets.
Mike Gitlin: Yeah. Thanks, Will.
What we're focused on most now is this shift from QE to QT [quantitatiave tightening]. So, after the global financial crisis, what you saw was central bankers rushing to ease financial conditions. They were lowering policy rates; they were buying assets. And that quantitative easing was pretty dramatic. If you look at three central banks in particular — the ECB [European Central Bank], the Bank of Japan and the Federal Reserve — the quantitative easing in total was over $15 trillion onto their three balance sheets. If you add China into that, you're over $20 trillion. And what's interesting — I don't think most people focus on it — is the Federal Reserve now has the fourth largest balance sheet out of those four. And the Federal Reserve is also beginning to unwind that balance sheet. By the end of this year, you are going to see $50 billion a month roll off the Fed's balance sheet.
So, in that move from QE to QT, financial conditions are going to tighten, necessarily. And so, we're focused on that and the impact [of] that on asset prices. If the easing we saw over years and years helped asset prices, a tightening would, by all accounts, have some challenges to asset prices. So, we're focused on that.
There is a benefit to the front end of the yield curve in the U.S. moving up. Income has effectively made a comeback. If you think back five years ago, the two-year U.S. Treasury yield was 200 basis points lower than the S&P 500 dividend yield. The two-year Treasury yield is now 60 basis points higher than the S&P 500 dividend yield. So, short-duration, high-quality fixed income has made a comeback in terms of income, and that's a positive thing for folks looking for higher income.
Will McKenna: I'm surprised to hear that statistic, that the Fed is the fourth of the four central banks; I bet our audience is surprised, too. Fair to say, we should probably expect more volatility in markets as they unwind some of the balance sheet going forward.
Mike Gitlin: Right. So, I think that's fair. If you look at fed funds implied, the market feels as if the U.S. fed funds rate will be something around 2.60% at the end of 2019. The European Central Bank is likely to stop buying assets altogether by the end of 2018, and there's even talk of the first rate hike in Europe sometime in 2019. China is unwinding some of their balance sheet. The Bank of Japan is on hold for awhile; you have a 10-year yield in Japan that's effectively benchmarked close to zero, so we don't see a lot of [movement] in terms of their balance sheet.
But globally, you should see these four central bank balance sheets, over time, become smaller, not bigger. And that's going to have a certain tightening effect, or challenge, to the economy — and certainly to asset prices — and in all likelihood, a pickup in volatility, which we've already begun to see.
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