The Late Cycle

This video is the first in a series on bond investing late in the cycle. For more on this topic, read our fixed-income outlook for 2020 and learn how the Federal Reserve maneuvers its balance sheet.

Scott DiMaggio: Eric, the Fed balance sheet is back in focus in financial markets for the past couple of months. The Fed has expanded the size of the balance sheet going into year-end. As we sit here in January, what impact do you think that’s had? What’s actually happening with the Fed balance sheet?

Eric Winograd: Basically, there were some problems in the money market that seemed like there wasn’t enough liquidity floating around, and so the Fed has injected money into the very short end of the yield curve.

And that’s an important difference between what they did with QE, where they were injecting money into the longer end of the yield curve. Now, they’ve put money into the short end of the yield curve to make money market rates behave. And, as a result of that, they’ve expanded the balance sheet by around 350 or 400 billion dollars, which is a lot of money.

My view is that this is different than quantitative easing—both because of where the money is going, in this case into money markets rather than into the longer end of the yield curve, and because of the intent.

Part of the value of quantitative easing [is] with the Fed saying, “We’re trying to boost the economy”; whereas, in this case, they’re just saying, “Well, we’re trying to fix the money markets.” And I think that they’ve done that. I think that the money market functioning has improved.

And because of that, we’re at a point where we don’t expect much more balance sheet expansion. I don’t think it’s had a large impact on the economy because of the different channels by which this is working compared to quantitative easing. But it does seem like it’s had an impact on financial markets. Don’t you think?

SD: Yeah, I totally agree.

And when we’ve talked about the balance sheet in the past, we’ve talked about it both in [terms of] the size and the change, and the delta or the change in the balance sheet over the past three to four months has meant a lot to asset markets.

If we think about 2019—it was a year where forty-nine central banks cut interest rates in some capacity. We kind of capped the year with the Fed expanding their balance sheet from what was, in their opinion, too low a level, Eric, as you said.

So, what we really saw is a response in all asset markets. We saw commodities, copper, gold move higher. We saw credit spreads tighten and we saw interest rates continuing to kind of fall or at least remain in the US in that 180 [basis point] to 2%-type range. Equities, of course, continue to make new highs.

So, whether we think the central bank balance sheet is the only stimulus, it’s proven to be one that’s really lifted all boats.

EW: Yeah, I think it’s pretty clear that monetary policy easing still works to stabilize financial markets. Left to be determined is what it means for the real economy, where, as you say, the evidence is quite a bit more mixed.