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How Will the US National Debt Benefit From Any Fed Policy?
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How Will the US National Debt Benefit From Any Fed Policy?

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NEW YORK – January 31, 2019

Can US Treasury bonds – an asset that the Federal Reserve has been buying up in unprecedented rounds of quantitative easing – benefit from a reduction in the Central Bank's balance sheet? Such a scenario is allowed by analysts of the Dutch Rabobank. Their argument is that a quantitative tightening, or QT, will have a negative impact on the fundamental economic situation, which in turn will reinforce the demand for US government securities as a protective tool.

The key finding of analysts is that the impact of a QT on the markets will not be a mirror image of what happened during Quantitative Easing (QE), when both bonds and shares won. Treasury securities will be able to grow, while risky assets will decline as the Fed’s balance sheet shrinks, they argue.

While most experts believe that a full-scale financial collapse in 20018 was avoided only thanks to the first round of QE, there was a wider debate around the subsequent stages of easing.

Rabobank strategists believe that QE’s policy prompted companies to invest in financial investments, rather than in productivity-enhancing equipment. The policy of the regulator allowed inefficient enterprises, the so-called "zombies,” to keep afloat due to the low cost of borrowing.

The risk of “dezombification” will increase, as companies will refinance more and more of a "commitment" at a higher rate, Rabobank strategists believe.

The withdrawal of these companies from the market will subsequently trigger an economic recession, they expect. This means that bond yields will have to fall for a long time before they can grow in response to collapse of the Fed's balance sheet.

How Will the US National Debt Benefit From Any Fed Policy?

The Rabobank team predicts a decline in the yield on 10-year US Treasury bonds to 2.40% by the end of the year — the lowest since December 2017, which closed the quarter in which the Fed started QT.

How Will the US National Debt Benefit From Any Fed Policy?

Now yields are trading at 2.74%. We’ll see how the markets react to the Fed's latest decision to leave the key rate unchanged.

Author: USA Really