Normalization

Central banks are combining different levers to manage the current economic environment. On one hand, they are cutting rates at an unprecedented rate for a non recessionary period. On the other, they have been reducing their balance sheets (mostly G7), which suffered a staggering expansion during the pandemic. In the chart below, you can see the Fed’s balance sheet and how it went from 35% of GDP to the current 22%. As a consequence of that, liquidity might’ve been running a little tight, and banks are showing signs of stress. It is no surprise then, that J Powell, in his last press conference after the FOMC committee in October, announced the en of QT (balance sheet reduction) and an euphemism for QE, which is buying T-bills with maturing MBS in their portfolio. The Fed will be injecting dollars in the system at a slow pace at the beginning, but it things continue to deteriorate, they will implement a full fledged QE, which will affect inflation down the road, and may force them to increase rates like they did in 2022, going back to square one. The severity of QE will depend on how hard the credit cycle is, which may have already started.

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