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The Long Unwinding Road

Central banks are set to unwind the extraordinary accommodation put in place since the global financial crisis. The US Federal Reserve (Fed) has commenced its transition from Quantitative Easing (QE) to Quantitative Exit and the European Central Bank (ECB) is preparing to taper asset purchases.

This Macro Insights follows up on the Outlook we released in July with a deep dive into the potential asset implications of the global QE retreat. GSAM investors discuss the key variables they’re watching that may alter the policy calculus and the market’s response to this watershed event.

Speed Read

We don't expect an "equal and opposite market reaction"…
QE depressed market volatility and bond yields, while boosting risk asset prices. A well-telegraphed and gradual QE retreat, coupled with excess liquidity from the global savings glut, can help prevent a sharp U-turn in asset prices. Bond yields will gradually rise, term premiums will normalize and yield curves will steepen, but we do not expect the QE unwind, alone, to be a force for higher volatility.
…but much will depend on the "known unknowns."
The QE retreat is a "known" event. Less certain, however, is the macro, policy, and political outlook, which all have the potential to dictate the magnitude of market moves. Fading economic momentum in Europe or a return to downward inflation surprises in the US could challenge the case for tighter monetary policy, while policymaker missteps and political uncertainty could drive a sharper asset response.
The impact will not be uniform across sectors or regions.
Even if the macro setting remains supportive, less monetary accommodation will expose vulnerabilities in assets and regions dependent on central bank buying. US Treasury bonds and Agency MBS will contend with both reduced Fed demand and increased net supply over the course of 2018. In Europe, fiscally weak countries, such as Italy and Portugal, will face higher borrowing costs when the ECB tapers its purchases.

Where Did QE Take Us?


Central bank asset purchases dampened risk premia and market volatility, while bolstering valuations for risk assets, including corporate credit and equities.

GSAM Investors Weigh In

We sat down with three of our investors to discuss how the QE unwind will play out and what events could buffer or exacerbate the market’s response.


Neill Nuttall
Co-Chief Investment Officer, Global Portfolio Solutions, Goldman Sachs Asset Management
Jonathan Beinner
Chief Investment Officer & Co-Head, Global Fixed Income, Goldman Sachs Asset Management
Alex Stiles
Portfolio Manager, Fixed Income Duration and Country Strategies, Goldman Sachs Asset Management

What could buffer the impact of the QE unwind?


Supportive macro backdrop


Beinner: QE is an unconventional policy, implemented in extraordinary times, which may explain why we saw such marked asset price reactions. In contrast, the QE unwind is occurring as economies normalize with low inflation and synchronized growth.

Less accommodative policy also does not imply tight policy. So far, the Fed is the only major central bank to begin a balance sheet runoff, while the ECB and BoJ continue with their QE programs, albeit at a reduced pace. Thus, the "stock" of global QE purchases is still expanding, though as noted in our Outlook, the peak "flow" of asset purchases is behind us. We may see more pronounced market moves as asset purchases grind to a complete halt, though we do not expect this until beyond 2018.


Well-telegraphed strategy


Nuttall: This concept of "stock" and "flow" has important market implications. Even the slightest hint around a change in the pace of asset purchases can trigger acute market reactions, which the Fed discovered after the 2013 Taper Tantrum. Central banks have since refined communications and we now obtain guidance in the form of press conferences and speeches before official policy meetings. The well-telegraphed strategy has worked to minimize the "announcement effect."


Global savings glut


Stiles: I would note two additional considerations. First, in Europe, the ECB will maintain low policy rates "for an extended period of time, and well past the horizon of the net asset purchases." This will keep European government bond yields anchored. Second, even as central bank liquidity fades, other forms of liquidity could keep a lid on government bond yields—from the excess savings of emerging market economies to liquidity from private sectors of developed market countries. Market participants have deployed these savings in assets, such as US Treasuries, which may continue to prop up developed market asset prices even as central bank liquidity wanes.


To view the rest of the interview, please download the full publication below


Download Full Publication




October 2017


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