What the Fed's Big Balance Sheet Unwind Means for Markets

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:15)

Joe, what was the biggest thing that happened in markets in recent months, over the summer? It's like a test. I think it's like a test of, you know, what people are looking at at the moment, what they find interesting.

Joe Weisenthal (0:29)

I mean, the Fed tightening, obviously.

Tracy Alloway (0:33)

Yes, this is the correct answer.

Joe Weisenthal (0:35)

Okay, I'll stop there. I got it right.

So I'm just gonna stop there and you can go on.

Tracy Alloway (0:40)

Okay, so the Fed started quantitative tightening. We're recording this in late June.

And weirdly, it kind of went by without that much fanfare. Like there were a few news articles about the Fed firing the starting gun on quantitative tightening and the unwind of its very, very large balance sheet. But there was so much going on at the same time. You know, there was that surprise 75 basis point interest rate hike and then lots of talk about inflation and things like that, that it feels like it didn't get as much attention as it probably should have.

Joe Weisenthal (1:14)

Most of the attention is paid to the rate, obviously. You know, QE, when it was first unveiled or when Ben Bernanke did QE too, which was the real QE during the great financial crisis, it got so much attention.

But there still seems to be a lot of ambiguity about A, how it works, what it does, what it accomplishes. And then in terms of like the degree to which unwinding the balance sheet is or is not an additional form of policy tightening is something that I just feel like is at best like still deeply misunderstood.

Tracy Alloway (1:50)

It is kind of crazy that even after years and years of quantitative easing, there's still a discussion about what the impact is and how it actually works.

I mean, I remember people still arguing about whether or not it pushes up asset prices and things like that. And there are people out there right now who are arguing that the reason markets have fallen might not actually have to do that much with inflation concerns and worries over a looming recession, but could just be because liquidity is starting to exit the system.

Joe Weisenthal (2:19)

No, no, I mean, it's totally valid. It's worth noting that we have had 2014 through 2018 markets boomed even though there was no longer a further expansion of the balance sheet.

We started to rally in early 2019 again, even as the balance sheet shrank for a while, going into some of the tensions. But it really is wild, as you say, like how little we know and how little, even, I mean, I think even the Fed knows about like measuring the effects of changes to the size of the balance sheet.

Tracy Alloway (2:56)

Well, there is also an argument to be made that the QE that we've seen over the past couple of years is stylistically and quantitatively different than the ones we've seen prior. And so the exit is going to be different too. So we are going to dig into all of these very big and technical questions.

And I'm happy to say we really do have the perfect person to discuss this. We're going to be speaking with someone who's been on the podcast before Joe, but I think you were actually away for that episode.

Joe Weisenthal (3:24)

Thrilled to have him back.

Tracy Alloway (3:25)

Yeah, so I'm thrilled to have him back. We're going to be speaking with Joseph Wang. He used to work at the New York Fed on the open markets desk conducting repo operations, basically being deep in the weeds of money markets. And now he runs a blog called Fed Guy, which is really a must read if you're interested in monetary policy and in all of these big questions about how it actually works.

So Joseph, thank you so much for coming back on Odd Lots.

Joseph Wang (3:52)

Hey Tracy, hey Joe. Thanks so much for inviting me. It's a pleasure to be here.

Tracy Alloway (3:56)

Yeah, so maybe just to begin with, could you give us the broad outline of how quantitative tightening or the QE that we've seen over the past couple of years, you know, as I alluded to, it's different to the QE that we've seen in the past. So I guess the question is, how different is it this time? Like what makes this particular exit different to previous periods of quantitative tightening that we've seen?