Combination of QT – slower money growth and higher interest rates- will cut consumer spending this year- Hoisington
Quantitative tightening (QT) i.e. tighter money, rising interest rates, low savings and high debt, could confound optimistic economists.
This is the view of Lacy Hunt, economist at Hoisington, a specialist US Treasury fund manager. Mr Hunt, an economic forecaster with an outstanding track record, has coined the term “QT” ie quantitative tightening. QT is the polar opposite of QE, or quantitative easing.
The US Federal Reserve Board (Fed), Bank of Japan (BOJ), European Central Bank (ECB) and Bank of England (BOE) applied QE. They purchased government bonds and other securities to flood the financial system. In the meantime they slashed interest rates to zero or even negative. The aim was to encourage banks, that sold securities for cash, to lend more money. Bank credit and zero rates would then boost economies.
QE had mixed results regarding economies. But it caused a surge in global stock, property, commodity and other markets. After a lengthy post-crash period, unemployment has fallen. Economies, especially the US, are at last growing faster. The Fed has become worried about inflation. It has thus embarked on QT to reduce the size of its inflated bond portfolio.
Mr Hunt spells out the application of QT and its consequences:
Based on the solid 3 percent plus GDP growth, the Fed intends to continue raising the federal funds rate in 2018.
Since December 2015, the Fed has raised the Fed Funds rate by 1.25 per cent by reducing liquidity in the banking system. These actions caused a reduction in the supply of credit via tighter bank lending standards. Borrowing demand also falls as some borrowers can no longer meet higher credit standards.
“The impact of this tightened Fed policy on money, credit and eventually economic growth is slow but inexorable,” Mr Hunt says.
The velocity of money ie financial transactions “is standing at its lowest level since 1949”. The supply of money, notably M2, has contracted from 7 percent in 2016 to 5 percent.
Meanwhile, QT has begun in earnest. In the fourth quarter of 2017 the Fed planned to reduce its balance sheet by $30 billion. This “puts additional downward pressure on money growth”. A $60 billion reduction is expected in the first quarter of 2018, another $90 billion reduction in the second quarter and an additional $270 billion in the second half of the year.
“The magnitude of this ($450 billion) balance sheet reduction is unprecedented,” says Mr Hunt. In the three months ended 2017, money supply growth slowed down further to 3.9 percent.
“If the Fed continues QT for one year, we calculate the overall change in M2 could turn negative by the end of the year.”
The Fed is taking these actions because its own forecasters and private sector economists are optimistic. They are expecting Donald Trump’s tax cuts and stronger European and Asian economies to keep the US humming. Bond yields are already rising in anticipation of higher inflation. Minutes of the ECB indicate that QT will begin in the Eurozone at some point this year. Britain is already applying QT.
Mr Hunt cautions that, while QT is taking place, US consumer spending will slide. In the past few years spending has been fuelled by a slump in saving rates and a further increase in debt. But growth in real incomes is weak and overall corporate profitability is overstated. The debt burden has become onerus, because of higher interest rates. The impact on consumption will thus be negative.
“The tax cuts should increase incentives and efficiencies, and possibly lower the cost of capital,” Hoisington notes. When President Reagan cut taxes in 1981, growth ensued. Yet government debt was then only 31 percent of gross domestic product. Today US government debt is 106 percent of GDP and both state and private sector debts are rising.
“The continuing debt build up will have the unintended consequence of slowing economic growth in 2018 and beyond, despite the tax cuts,” Hoisington maintains.
If Hoisington’s analysis is correct, high and rising government and private debt in the UK, the rest of Europe, China and other nations, could also disappoint.
The question is whether the Fed and other central banks would then loosen money. They could do so if stock markets tumbled.
Do you think Hoisington’s Lacy Hunt is too pessimistic? Comments are below.
(This article was first published in The Business Times, Singapore.)
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