If you are wondering what is quantitative tightening and see the word thrown about a lot but aren’t sure if you know what it means, then you have come to the right place.

We will not only discuss what is quantitative tightening but will also explain how it operates and how it will affect the markets, so you can get answers to all your questions right here!

What is Quantitative Tightening?

As you may have guessed from the word "tightening", it is a monetary policy used by the central banks to curb or tighten the availability of cash within an economy. A further simplified explanation is that it’s a method used by the bank to reduce the cash available to people and businesses within an economy/country.

Quantitative tightening (QT) is coming in the aftermath of quantitative easing. Yes, you guessed it right, it's the opposite of QT and means that the central and/or federal banks are taking steps to inject cash/liquidity into the economy in an effort to boost demand, purchase and economic activities. So, if it boosts the economy why would banks indulge in QT?

Well, quantitative easing (among other factors) can result in higher inflation. To control the high inflation rates, the bank reduces the liquidity in the market.

How does Quantitative Tightening happen?

The Central Bank adopts multiple ways to roll out QT. One of the ways is that they stop purchasing the government bonds and may even sell the bonds that they are holding to reduce liquidity. The Central Bank may not reinvest the money received from the maturity of the existing bonds. Another way is by increasing the interest rates. Higher interest rates disincentivize lending money to high-risk businesses and individuals and thereby reduce the liquidity in the market which reduces demand and spending.

How will it impact the markets?

Quantitative tightening is not just limited to one economy alone rather, the EU, Japan, UK and the US are all likely to initiate QT. Since the Central Bank/Federal Bank will not be buying the government bonds, they will then be offered to private buyers. Unlike Central/Federal Bank, the private buyers are likely to negotiate the price of the government bonds resulting in receiving better interest on their investment.

This will result in reduced lending by private banks since government bonds are the most secure and least risky investments, especially when compared to businesses and individuals.

Unsurprisingly, the moment QT was announced, the equities fell because equities are considered high risk compared to government bonds. Availability of government bonds to private buyers resulted in them investing in government bonds over equities which led to the dip in the equities.

One particular segment of equities is highly susceptible to QT – “growth shares. Growth shares are made of technology and consumer staple stocks. These stocks were performing particularly well in the low inflation and low-interest environment that was existing. However, with increasing inflation and now higher interest, there is a possibility that these stocks will be impacted unfavourably.

There’s also the issue of QT being undertaken by many financial markets which has a possibility of cascading economic slowdown resulting in bearish investor sentiments. Bearish investor sentiments will affect the equities market negatively and result in more bearish investor sentiments.

This along with the fact that during the last 2 years, central banks globally injected over $10 trillion in liquidity. Morgan Stanley anticipates that globally, in the next 12 months, central banks across the world will reduce liquidity by about $2 trillion. It is set to continue making investors skittish and markets volatile.

How to tide over this?

Many experts believe that the quantum of QT will be less than quantitative easing that had been going on and so overall, the impact of QT will be limited. Further, since the QT efforts across the globe are not synchronized, the cascading effect, if any, would be limited. Though, this has done little to curtail the volatility in the markets and placate investor sentiments – which is likely to continue driving volatility in the near future.

Of course, this market volatility can be an opportunity for many to pick up quality growth stock and reasonable prices, as suggested by Morgan Stanley.

We hope that you have enjoyed this article and it has informed you about what quantitative tightening is, why it is being used and how it may affect the markets in the coming months. If you need help sending money from Canada to anywhere in the world whether to invest in global markets to take advantage of the volatility or perhaps your family living abroad, avail of RemitBee’s remittance services.

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References

-www.economist.com - corporatefinanceinstitute.com - www.ftadviser.com - www.ftadviser.com - www.morganstanley.com - economictimes.indiatimes.com