QT on the QT

As monetary policy has become increasingly important to financial markets, it is not surprising that discussions about rate increases have become fairly intense. Such discussions have taken on the character of barroom arguments over subjects like the best baseball player in history: Everyone has an opinion and will argue it with anybody in earshot.

What is far less discussed, however, is the program of quantitative tightening (QT). To be sure, the Fed has been fairly quiet itself on the subject, but the subject hasn't resonated strongly with the investment community either. This creates an opportunity of sorts. Because the low profile of QT belies its significant potential to cause harm, those who are familiar with the mechanism will have a leg up navigating the consequences.

Bad estimates

A good place to start an investigation of QT is to better understand why it has been so understated. Part of the reason is due to the fact the Fed missed important inflation signals and continued QE for too long.

For instance, a year ago, at the end of the summer of 2021, the 10-year Treasury yielded just above 1.3%. Part of the reason the yield was so low was because there was a widespread belief inflation would be transitory. Part of the reason for the belief in transitory inflation was because that was the message the Fed regularly and loudly communicated. It was wrong.

Indeed, it was so wrong it prompted Gary Shilling to exclaim in a recent note, “The Federal Reserve’s forward guidance program has been a disaster, so much so that it has strained the central bank’s credibility.” He goes on to explain the main problem with forward guidance has been “that it depends on data that the Fed had a miserable record of forecasting.”