'Not our base case': Fed unlikely to unleash printing presses, QE, to offset US/China trade war

AMP economist My Bui has hosed down speculation the US Federal Reserve could start a bond buying program to artificially cap government borrowing costs if they surge again on worries about the inflationary impacts of trade barriers between the US and China. 

On April 11, Boston Federal Reserve Governor Susan Collins told the Financial Times, the US central bank is "absolutely" prepared to intervene in markets if necessary, after President Trump's tariff policies sent bond and equity markets into a nosedive. 

Past bond buying programs - known as quantitative easing (QE) - to combat downturns during the GFC of 2009 and pandemic-era lockdowns in 2020/21 stoked stock and property market price rebounds, as borrowing rates fell and money supply ballooned.

"Our base case is we don't see the Fed doing it [QE] at the moment," said Bui.

"In the short term QE - aka more liquidity - calms markets and benefits investors.

"It would also devalue the US dollar and increase CPI [inflation] as it's more expensive for people to buy things. Inflation is the Fed's biggest concern at the moment, as you've already seen goods inflation bouncing back over the past few months."

Last Friday, Collins, who sits on the Fed's 12-member interest rate setting committee, suggested the central bank had several policy options beyond interest rate cuts to calm markets if a downturn comes. 

The message comes after bond market yields rallied over the final quarter of 2024, despite the US Fed implementing an emergency 50 basis point rate cut in September 2024. 

"QE would probably hurt the Fed's credibility a little as it could be seen as bailing out the government with lower yields and that's rumoured to be what the US administration wants," said Bui. 

"If the Fed's credibility is hurt it could weaken the appeal of US assets even further over the medium or long term, so that's another reason why we don't see them stepping in." 

Others such as Tim Toohey, Yarra Capital's head of macro economics and strategy, said the Fed wouldn't go back to QE other than in emergency circumstances and after cash rate cuts had reached their 'lower bound' to mean additional cuts are unlikely to stimulate spending or investment. 

"Although a case could be made for intervention in the bond market to ease concerns over sovereign risk, we would need to see extreme price movements for large-scale intervention to occur," said Toohey.  

"More likely, any dislocation in the US bond market would be met with smoothing operations rather than a return to full-scale QE." 

"Equities would clearly derate in response to a sharp rise in sovereign bond risk premiums, both from a valuation standpoint and due to the implications for corporate and household interest costs."

No dysfunction as yet

Current financial indicators around liquidity or panic in financial markets also show little sign of a problem, according to Bui. 

As reference points to watch, the economist pointed to metrics such as the spread between BBB rated bonds and benchmark risk free US 10-year treasuries, and the spread between the overnight inter-bank lending rate (the secured overnight financing rate (SOFR)) and short-term three-month treasury bills. 

"If you look at historical data whenever they do QE it means there's persistent disruption in markets, clear market dysfunction, limited liquidity, or capital freezes. And we we don't really see that at the moment," she said.

"Actually, BBB spreads to 10-years are around the same level as last August."

The last time spreads between SOFR and three-month treasury bills spiked was during the US regional banking crisis sparked by the collapse of Silicon Valley Bank (SVB) in March 2023.

Normally spreads between SOFR and three-month treasury bills should track each other consistently given the short duration risk, although at times of financial, liquidity, or bad debt stress the spread could spike, according to Bui. 

"[The spread's] a good way to gauge whether markets see a big spike in liquidity needs," she said.

As the SVB crisis spilled over into financial markets the spread between lower-rated commercial bank debt and government bonds also widened, as the market worried about contagion and the solvency of US banks. 

For share market investors it seems unlikely the Fed will ride to the rescue and print more money to support asset prices over the short term, although Collins also told the Financial Times the central bank has multiple tools at its disposal to intervene in markets.

"In March 2023 they had the Bank Term Funding Program (BTFP) in terms of emergency relief, or maybe then can loosen liquidity or capital requirements for commercial banks as well as alternatives," says Bui.  

Overnight in the US, Bloomberg's MOVE Index - as a tracker of bond market volatility - eased 5%, while yields on benchmark US 10-year treasuries cooled 12 basis points to 4.36%, after last week's capital markets rollercoaster.

In Australia, interest rate futures traders are now fully priced for a 25 basis point cut from the Reserve Bank on May 20, with an implied cash rate around 2.89% for the end of year to mean the market expects between a total of four or five more 25 basis point cuts this year.