The Fed is about to start unwinding its unprecedentedly large balance sheet — and no one knows what will happen
REUTERS/Kevin Lamarque
“We’ve never had QE like this before, and we’ve never had unwinding like this before,” said JPMorgan CEO Jamie Dimon at the Europlace finance conference in Paris. “Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before.”
He was referring to the Fed’s plan to unwind QE, shedding Treasury securities and mortgage-backed securities on its balance sheet. The Fed will likely announce the kick-off this year, possibly at its September meeting.
According to its plan, there will be a phase-in period. It will unload $10 billion the first month and raise that to $50 billion over the next 12 months. Then it will continue at that pace to achieve its “balance sheet normalization.” Just like the Fed “created” this money during QE to buy these assets, it will “destroy” this money at a rate of $50 billion a month, or $600 billion a year. It’s the reverse of QE, with reverse effects.
Other central banks are in a similar boat. The Fed, the Bank of Japan, and the ECB together have loaded up their balance sheets with $14 trillion in assets. Unwinding this is going to have some impact – likely reversing some of the asset price inflation in stocks, bonds, real estate, and other markets that these gigantic bouts of asset buying have caused.
The Bank of Japan has been quietly tapering its asset purchases for a while to where it buys only enough to keep the 10-year yield barely above zero. And the ECB has tapered its monthly purchases by €20 billion earlier this year and is preparing the markets for more tapering. Once central banks stop buying assets, the phase starts when central banks try to unload some of those assets. The Fed is at the threshold of this phase.
Dimon was less concerned about the Fed’s rate hikes. People are too focused on rate hikes, he said, according to a Bloomberg recording of the conference. If the economy is strong, economic growth itself overcomes the issues posed by higher rates, he said. The economy has been through rate hikes many times before. They’re a known quantity.
But “when selling securities in the market place starts,” that’s when it gets serious.
“When that happens of size or substance, it could be a little more disruptive than people think,” he said. Whatever it will do, no one knows what it will do – because “it never happened before.”
“We act like we know exactly how it’s going to happen, and we don’t,” he said. Central banks “would like to provide all of you with certainty, but you cannot make things certain that are uncertain.”
“We don’t know how that is going to play out,” he added.
All the main buyers of sovereign debt over the past decade – central banks, financial institutions, foreign exchange managers – will become net sellers now, he said according to Bloomberg. “That is a very different world you have to operate in, that’s a big change in the tide.”
In other words, no one knows how this is going to work out. It’s part of the great journey into experimental monetary policy.
QE had the intended effect: inflating asset prices – stocks, bonds, real estate, classic cars, art… which made it much harder for people who have to rely on labor for their income to buy these assets – or to rent them, such as housing. Unwinding QE, once it starts in earnest, is likely to pull asset prices in the opposite direction. But given of how leveraged assets are, and to the enormous extent they have been used as collateral, Dimon – the banker who is concerned about collateral values – hit the nail on the head. It’ll be “a very different world.”
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