Until now we're been in quantitative easing (QE), which has driven up stock prices and pushed bonds down. Does transitioning into QT imply the reverse?
If you believe in value investing, the same process has pushed stock yields down (where yield is measured in terms of earnings, ie the reciprocal of the P/E ratio).
A step change down in interest rates can drive a rapid price appreciation in stocks as the value of future earnings gets pulled forward, at the cost of slower long-term appreciation after that run-up.
Yes.
I'm not very knowledgeable here so please correct me if I'm wrong please.
Correct.
When bonds go up rates go down. This is mathematical fact. (If a bond at 100 pays a $1 coupon, i.e. 1%, it pays ~0.91% when that bond trades at 110.) When rates go down, asset prices go up. This isn't mathematical fact, but it's close to economic fact. (If rates are 5%, a bond yields the same as the earnings on a stock at P/E 20. That limits P/E ratios which caps stock prices.)
QE means buying bonds so rates go down. QT is the inverse. Selling bonds so rates go up.
But the real amazing part is that when the Fed buys something (and the only thing they ever buy is bonds) they just wish the money into existence. They take your bond and write a number in your account. And when they sell something back, the bond goes to the buyer and the money disappears.
If you expand currency to money this describes all financial institutions. Financial institution balance sheets are weird. The Fed's is almost simpler by comparison.
Don't all currency-issuing entities do that? I guess the Fed would be unique for US currency.
All central banks do. Coins aren't a liability of the U.S. Treasury's in the way Federal Reserve notes are for the Fed.
In layman terms you are lending money to the bank and the bank owes you a debt. The central bank does the same thing but the depositors are commercial banks in this scenario.
>But the real amazing part is that when the Fed buys something (and the only thing they ever buy is bonds) they just wish the money into existence. They take your bond and write a number in your account. And when they sell something back, the bond goes to the buyer and the money disappears.
They wish bank reserves into existence taking an asset and creating a liability in equal proportion. By the way, commercial banks do the same thing and when they lend you money, you can actually buy things with it instead of only being able to use the fed money to lend to consumers and companies! Wow, commercial banks are amazing (sarcasm), they don't create the "useless" funny money (reserves) that the Fed creates that you can't even spend on groceries!
I just realized that this rabbit hole is too long to explain over and over again. Here is a nice summary: https://youtu.be/ZFRVfXeIaek
Rates.