Emerging market macros make valuations even more attractive
This article first appeared on Trustnet on 30 November 2023 What’s the first thing which comes to...
Acronyms and abbreviations are very much part of our everyday language but when it comes to financial abbreviations, they can seem a little daunting, especially when it seems everyone else already knows the answer!
So let’s break down quantitative easing, or QE, and its buddy, quantitative tightening (QT).
You might’ve heard about central banks like the Bank of England or the Fed (that’s the one in the U.S.) doing some “money magic”. Essentially, QE is when these central banks whip up more money and start buying up various things, like government bonds (debt issued from the UK or US government, for example) or even corporate debt and mortgage debt.
The idea behind QE is the same as lowering interest rates. It increases the money supply and injects more money into the economy.
QE is a bit like getting a little extra allowance money when you’re a child. Your parents may do this to encourage you to spend more, save more, or even invest in cool stuff.
Similarly, central banks hope that by pouring more money into the economy, it’ll get people excited to spend, invest, and drive the economy forward.
Now, when these banks go around buying your government bonds off you, investors are left with a pile of cash in hand. The catch? You’ve got to do something with it.
What happens is some investors will venture away from those government bonds and head towards riskier investments – this is because government bonds weren’t bringing in a high enough yield.
Too much money swirling around without enough things to buy can lead to trouble.
Think of it like this: if everyone wants the same limited-edition trainers but there aren’t enough pairs to go around, the prices shoot up, right? That’s the problem with too much demand, it can lead to inflation.
And that’s the concern with QE — it can pump up demand so much that there aren’t enough goods and services to satisfy everyone, which can lead to prices climbing. Sound familiar? That’s what’s been going on lately.
So, to combat this inflation bonanza, central banks do a little switcheroo called quantitative tightening, or QT. It’s basically the reverse of QE.
Instead of tossing money into the mix, they start pulling some out.
How? Well, when those bonds the central bank bought reach their due date (maturity) and the money comes back, the bank says, “Nope, we don’t need it anymore,” and just like that, the money vanishes into thin air (or near enough, you get the idea). It’s like your savings disappearing from your piggy bank, but on a grand scale.
And in the case of the Bank of England, they’re not just letting those bonds sit around — they’re actually selling them off and scrapping the money they get back. This shrinks the amount of money sloshing around and trims down the central bank’s financial statement.
So, there you have it!
Think of it like this, QE is the party starter, gets the money flowing, while QT is the friend who says, “Okay, that’s enough dancing, time to head home.”