How to approach investing in AI
November 29, 2018
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.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by the distributor of the American Funds mutual funds, which receives fees for distributing and servicing the funds.
Information provided on this website is intended for use by financial advisors with persons who are eligible to purchase U.S.-registered mutual funds.
Securities offered through American Funds Distributors, Inc.
Any reference to a company, product or service does not constitute endorsement or recommendation for purchase and should not be considered investment advice.
© 2018 Capital Group. All rights reserved.