Beware the Q Trap

BlackRock Investment Institute |06-Sep-2018

Renewed volatility in risk assets has contrasted with a bright growth outlook: The BlackRock Growth GPS suggests potential upside surprises to the consensus. Some market participants believe trouble spots such as Turkey are due to quantitative tightening (QT) – G3 central banks shrinking their balance sheets, either actual (Federal Reserve) or expected. This view holds that earlier quantitative easing (QE) inflated asset values and artificially compressed market volatility. In a mirror image, QT’s drain of liquidity from the financial system should put pressure on risk assets. The narrative seems intuitive, yet we believe the reality is more complicated and warn against the Q Trap – becoming trapped into thinking it’s about QE going into reverse.


  • We don’t see QT as QE in reverse. QE was the only game in town when interest rates hit zero and crisis-hit balance sheets in the private sector retrenched. Global financial conditions were under severe strain in 2008-2009. That’s no longer the case. Private sector credit growth is solid. “Liquidity” on this measure is not contracting. The Fed’s well-telegraphed and steady policy normalisation has also limited QT’s impact – as would our expectation for the Fed to stop shrinking its balance sheet next year.
  • QE’s influence on risk assets may not have been as large as many assume: Risk assets have not enjoyed a non-stop ride higher, with emerging markets (EM) in particular suffering periodic hits. We believe QE’s success worked not only via the portfolio rebalancing channel but also the signalling effect committing to low rates for longer. Together they put extra downward pressure on interest rates and helped revive risk appetite. And QE was just one factor behind low rates: Global savings seeking the perceived safety of G3 bonds have also squeezed the term premium, in our view.
  • What matters more for current financial conditions are interest rates, not central bank balance sheets. Low G3 rates still support risk taking, even as the Fed lifts rates closer to neutral levels. Yet higher U.S. rates are creating competition for capital and spurring a rebalancing of portfolios. Higher rates have also sparked U.S. dollar strength. What’s key is how risk appetite will hold up: Ongoing or greater macro uncertainty could prompt investors to demand higher risk premia across asset classes.


The loose interaction between private sector money and the central bank’s influence over private credit creation has changed constantly over time. The Less sluggish money chart shows trends in the U.S. money multiplier over nearly a century. We expect a further improvement in the money multiplier within the range in the orange band below. What’s clear is that the Fed influences the backdrop in which private credit liquidity plays out – and animal spirits take over. This dynamic is not tied to the Fed’s own balance in any static fashion. We have come a long way from the global financial crisis: Banks are better capitalised, more tightly regulated and less leveraged. Importantly, risk appetite has recovered across the private sector. Private credit creation should offset the Fed’s actions to adjust its balance sheet back to something more normal, in our view.

Less sluggish money

US money multiplier and BlackRock projection with recession bands, 1925-2021

Chart: Less sluggish money

Sources: BlackRock Investment Institute, Federal Reserve and New York Fed, with data from Haver Analytics, August 2018.
Notes: We show the money multiplier – M2 divided by the monetary base – and make a simple projection to 2021. Our projection assumes M2 keeps growing similarly to its trend in recent years. We then give a range of estimates of how the Fed's balance sheet may evolve in coming years, assuming that it will likely keep a larger balance sheet to maintain is current "floor" system of managing the fed funds rate. Our assumption is the Fed's SOMA account will ultimately range somewhere between $3.3 trillion and $3.9 trillion based on the June 2018 New York Fed survey of primary dealers.

Jean Boivin
Global Head of Research, BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is Global Head of Research for the Blackrock Investment Institute and is a member of the EMEA Executive Committee.
Elga Bartsch
Head of Economic and Markets Research, BlackRock Investment Institute
Tara Rice
Deputy Head of Economic and Markets Research, BlackRock Investment Institute

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