Quantitative Tightening

Quantitative Tightening (QT) is the opposite version of Quantitative Easing (QE), in which the central bank tightens liquidity in the financial market by reducing its balance sheet and raising interest rates.

Quantitative easing is an unconventional monetary policy in which the central bank purchases large amounts of government bonds, agency bonds, real estate mortgage-backed bonds and other assets to inject funds into the market, lower interest rates, and stimulate investment and consumption when facing a financial crisis or economic recession.

Quantitative tightening is a monetary policy that the central bank uses to prevent asset bubbles or out-of-control inflation by reducing the assets it holds, recycling funds on the market, and raising interest rates when the economy recovers or inflationary pressure rises.

The main goal of quantitative tightening is to raise interest rates and normalize them

One side effect of quantitative easing is to lower long-term interest rates, which makes the risk premium in the market smaller. Investors' demand for high-risk, high-return assets increases, leading to an increase in the prices of assets such as the stock market and real estate market.

Quantitative tightening is to reverse this process and bring long-term interest rates back to normal levels, which will increase the risk premium in the market and reduce investor demand for high-risk, high-return assets, leading to a decline in the prices of assets such as the stock market and real estate market. or stable.

There are two main methods of quantitative tightening: no longer buying or selling bonds

When a central bank engages in quantitative easing, it purchases large amounts of assets such as government bonds, agency bonds, or mortgage-backed securities and places them on its balance sheet. These assets have a certain maturity date, and on the maturity date, the central bank can get back the principal and interest.

When the central bank performs quantitative tightening, there are two ways to reduce the assets it holds:

Runoff: When the bonds held by the central bank mature, it will no longer use the recovered principal to purchase new bonds, but will keep the principal in its own hands. This is equivalent to withdrawing money from the market and reducing market liquidity.

Selling bonds: When the central bank holds bonds that have not yet matured, it actively sells them to recover funds from the market. This is equivalent to withdrawing money from the market and reducing market liquidity.

What are the impacts of quantitative tightening?

The impact of quantitative tightening on financial markets mainly includes the following aspects:

Falling bond prices: When the central bank reduces its holdings or sells bonds, it increases the supply of bonds on the market while demand remains the same or decreases, causing bond prices to fall and interest rates to rise. This is bad for investors who hold bonds because the value of their bonds will decrease.

Stock price declines or fluctuations: When the central bank tightens market liquidity, it will increase the financing costs of companies and individuals, reduce their willingness to invest and consume, and have a negative impact on corporate profitability and economic growth. At the same time, when bond interest rates rise, it will reduce the relative attractiveness of stocks, causing investors to shift from the stock market to the bond market, resulting in reduced demand for stocks and falling prices. This is detrimental to investors who hold shares because the value of their shares will be reduced.

Currency exchange rate appreciation: When the central bank tightens market liquidity, it will increase the scarcity and purchasing power of the country's currency, causing the country's currency to appreciate relative to other countries' currencies. This is detrimental to the country's exporters, as their products will become more expensive and less competitive in the international market. At the same time, this will also lower the country's import price level and reduce inflationary pressure.

The relationship between quantitative tightening and other monetary policies

Quantitative tightening is not the only monetary policy tool of the central bank. The central bank can also adjust market liquidity and interest rate levels in other ways. For example:

Tapering: refers to the central bank reducing the scale of monthly bond purchases and gradually exiting the quantitative easing policy when conducting quantitative easing. This is the transitional stage between quantitative easing and quantitative tightening.

Raising Interest Rate: refers to the central bank increasing its borrowing or deposit interest rates from commercial banks, affecting short-term interest rates in the market. This is the most commonly used monetary policy tool by central banks.

Generally speaking, the central bank will first reduce bond purchases before implementing quantitative tightening; it will then raise interest rates after implementing quantitative tightening. This avoids market overreaction or panic.