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Why Fed Disagrees with Trump on Quantitative Tightening

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Quantitative tightening

Last week, US President Donald Trump said that the Federal Reserve “should drop rates and get rid of quantitative tightening.” On prior occasions, Trump has lashed out at the Fed for raising rates too quickly and blamed the tightening for slowing the economy. In last month’s policy meeting, the Fed said that it would slow down the pace of trimming its balance sheet and would halt the process altogether in September.

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Meanwhile, while some analysts and President Trump see quantitative tightening as a problem, the Fed has disagreed with this opinion. In a research paper, while the St. Louis Fed admitted that rate hikes would slow the economy, it countered the argument that quantitative tightening is also affecting economic activity.

Fed’s argument

The report cites several reasons to support its argument. First, it said, “beneficial liquidity effects on yields will not be reversed, as they resulted from the repair of temporarily illiquid markets.” Second, it said, “much of the original benefit of unusual monetary accommodation has been gone for some time.” It also argued that while the Fed has been buying more long-term bonds to lower yields, the effect has been offset by the Treasury’s issuance of more long-term bonds at lower yields. Finally, it says “the gradual reduction of portfolio balance and local supply effects will produce small and gradual yield changes of a few basis points per year for many years.”

Meanwhile, markets have looked strong so far in 2019. All the FAANG stocks including Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Google (GOOG) are trading with double-digit year-to-date gains. The SPDR S&P 500 ETF (SPY) is up 16.0% YTD, while the Invesco QQQ ETF (QQQ) is up 20.2%.

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