I recently attended an event in the US where the former Chairperson of the US Federal Reserve (Fed), Ms Janet Yellen spoke. As one of the architects of the Quantitative Easing (QE) program after the Global Financial Crisis (GFC), then being responsible for starting the Quantitative Tightening (QT) program, her comments are important and reflect current Fed monetary policy. 

When the GFC occurred in 2007/08, the Fed’s balance sheet was USD1 trillion. The QE program expanded the balance sheet to USD4.5 trillion, as the Fed purchased all types of loans, including Mortgage Backed Securities (MBS) where historically the Fed through open market operations only acquired US Treasuries. QE combined with lower official interest rates devalued the USD and distorted the yield curves disrupting debt capital markets. It also allowed banks to repair their balance sheets without necessarily raising equity capital. 

With QT, the aim is to reduce the Fed’s balance sheet down to USD3.5 trillion, not USD1 trillion (pre-GFC levels).  So far the balance sheet has been shrunk by USD500 billion which means there is only USD500 billion to go. Chairperson Yellen stressed that the intention is to maintain a large balance sheet and that the Fed was not in any rush or feels any pressure to reduce it at a faster rate, and equally, the Fed would progressively increase interest rates depending on economic conditions. 

So what does this mean for investing – Rates will continue to rise over time., if economic conditions allow, e.g. low unemployment and inflation, as well as strong consumer demand. So keep your eye on the 10 year US Treasury interest rate as many products are priced off this rate.  Prior to Christmas it was around 3.2%, now its back at 2.8% range. This compares with the historical yield on the S&P 500 index of 2.15%. 

In response to questions regarding another financial crisis Chairperson Yellen outlined that no-one could guarantee another would not happen; however she outlined the significant steps that have been taken to mitigate the impacts. These steps included:

1. Requiring all banks to hold more capital

2. The capital being held is of better quality

3. Banks are required to hold more liquidity

4. Major banks must stress test

5. Better regulations

6. Large investment banks are now part of Federal Depository Banks

7. Reforms to shadow banking and derivatives clearing

8. Dodd Frank Act.

I trust the above is helpful, and as usual if you have any questions please feel free to contact us.