Goldman Sachs: Only the Fed Can Undo QE—Not Foreign Central Banks
Emerging-market central banks have been dumping U.S. dollar assets accumulated over the boom years in an effort to support their domestic currencies.
Deutsche Bank dubbed this development "quantitative tightening," or "QT," singling out China's sales of foreign exchange reserves as the proximate cause of the market's woes in late August.
"The People's Bank of China's actions are equivalent to an unwind of QE," said foreign exchange strategist George Saravelos.
But according to Goldman Sachs senior economist Zach Pandl, QT ain't all it's cracked up to be.
On the surface, recent foreign exchange reserve sales from emerging-market central banks are the mirror image of quantitative easing, the economist admits.
Assets held in foreign reserve portfolios typically have a much shorter average maturity than assets the Federal Reserve bought during its rounds of bond purchases, so it takes a greater amount of selling in nominal dollar terms to have a similar impact in duration terms. From 2010 until mid-2014, these central banks purchased the equivalent of $15 billion in 10-year U.S. Treasuries each month. Now they're selling about $34 billion worth per month.
That $50 billion net swing is roughly equivalent to the monthly purchases made by the Federal Reserve during its second round of bond purchases, known as QE2, noted Pandl:
"It seems inconceivable that [U.S. dollar denominated asset sales] could approach the scale of the Fed’s QE programs, which would require EM central banks to sell about $4.2 trillion in reserves (given their low duration), or about half of the current stock," he asserted.
Even if the current pace of selling continues for nine to 10 months, which Pandl deemed to be a realistic possibility, the economist didn't think it will have a large negative impact on U.S. financial conditions.
He highlighted three reasons why a phase of U.S. Treasury sales by foreign central banks wouldn't match QE's effect in a dollar-for-dollar fashion, but in reverse.
First, these sales have no signaling value, a dynamic that amplified the benefits of asset purchases by the Fed. Extra knowledge regarding the evolution and course of monetary policy will not be gleaned during emerging-market reserve divestments. It simply wouldn't be in the best interests of foreign central banks to declare their intent to sell a given amount of U.S. dollar denominated assets at scheduled intervals ahead of the fact, as the Fed did when it was buying bonds.
In addition, sales of U.S. Treasuries do not exert one-way pressure on financial conditions. On the one hand, this development exerts upward pressure on yields, effectively tightening financial conditions. But on the other hand, reserve sales foster weakness in the U.S. dollar, the strength of which is a key input in Goldman Sachs's (and many other's) financial conditions index.
Finally, it is evident that quantitative tightening has its limits: The amount of reserves these central banks are able to get rid of is finite. Quantitative easing, by contrast, can be open-ended, like the Fed's third round of asset purchases.
"[W]hile QE and QT share some common traits, only the Fed can put QE in reverse," concluded Pandl.