Economy

Brussels has launched legal action against the UK over the implementation of the Northern Ireland protocol, as relations between the two sides deteriorate over Boris Johnson’s plans to rip up the key provision of his 2020 Brexit deal with the EU. The European Commission on Wednesday announced it will resume a previously paused legal action against the UK for failing to implement full border checks in Northern Ireland. These were set up by the protocol, the part of the Brexit deal that covers trading arrangements in the region, which is intended to prevent a hard border in the island of Ireland.Brussels is also beginning two additional infringement actions over data sharing and health and safety checks. The moves were unveiled by European Commission vice-president Maroš Šefčovič following legislation published by London this week that would in effect rip up much of the protocol by eliminating some border checks, sidelining the European Court of Justice and giving British ministers powers to override the agreement. The infringement proceedings could ultimately lead to fines against the UK. “There is no legal, nor political justification whatsoever for unilaterally changing an international agreement,” Šefčovič said. “Let’s call a spade a spade: this is illegal. The UK bill is extremely damaging to mutual trust and respect between EU and UK. It has created deep uncertainty.” He said the commission had been holding back from launching legal action for the past year “because we were seeking constructive solutions.”Šefčovič said he had been laying out possible avenues to use measures already included in the protocol to smooth trade frictions, in the hope of a negotiated settlement of the EU’s differences with the UK over the protocol. “Despite today’s action, our door remains open to dialogue,” he said, as long as there were safeguards included in protecting the EU single market. The new UK legislation still faces stiff obstacles in parliament, particularly in the House of Lords. Johnson defied a chorus of criticism in moving ahead with the bill, insisting there was “no other way” of protecting the peace process in Northern Ireland.The region’s biggest unionist party said it will not return to Northern Ireland’s power-sharing executive unless the protocol is rewritten to eliminate the de facto border in the Irish Sea.

However, the British government’s plans have angered many in Brussels, Dublin and beyond. Simon Coveney, Ireland’s foreign minister, said Johnson’s unilateral approach marked a “new low” and amounted to a breach of international law, while a majority of elected members of Northern Ireland’s assembly also attacked the move.“Do I see anything positive in the UK bill? No, neither on message, nor on substance,” said an EU official on Wednesday. An EU infringement procedure can last several months before a case is referred to the EU top court, which can impose fines on the UK. But the EU also has other means of pressure, such as increased checks by national customs authorities on goods coming from Britain into countries such as France, Belgium and the Netherlands.If Johnson manages to get the legislation enacted into law, it could pave the way to the EU imposing tariffs to British goods, or ultimately even ending parts of its post-Brexit trade deal. More

Bloomsbury Publishing reported record sales and profit, as the publisher behind the Harry Potter series predicted books would not be hit by the cost of living crisis in the way subscriptions have.The London-listed company said on Wednesday that sales jumped 24 per cent to £230.1mn in the year ending February, while pre-tax profits were up 28 per cent to £22.2mn.“The question on all of our minds was: would the pandemic surge in reading continue? We now know the answer: reading has become a reacquired habit and continues to thrive,” chief executive Nigel Newton said.He told the Financial Times that books were an “affordable luxury” that readers were still likely to buy, even as inflation hit disposable income.“We saw a little moment in April — the month that Netflix warned on subscribers — when our own sales were light and thought: ‘oh boy, here we go, the cost of living crisis’,” Newton said. “But it turned out to be a mirage, and sales surged ahead in May.”Newton also pointed to a higher share of digital sales in the company’s academic division. He said more than half of the company’s sales were backlist titles that were cheaper to republish than newly commissioned work. Sales of books belonging to the Harry Potter franchise grew 5 per cent in the past year, 24 years after the first one was published.Shares in Bloomsbury rose 5 per cent on Wednesday morning. Analysts at Investec said the company’s “excellent” results had been achieved during a year of supply chain issues in paper and print cost inflation.

Some of Bloomsbury’s bestselling titles this year included Piranesi by Susanna Clarke as well as Nicole Perlroth’s This Is How They Tell Me The World Ends, and hobby-driven books on topics such as cooking continued to do well.Newton said the price of books could rise in the next few months, as inflation continued to hit manufacturing and transport costs, adding that “we review our pricing monthly”.Bloomsbury last year bought the California-based online academic publisher ABC-CLIO, as well as Red Globe Press, which previously belonged to Springer Nature.It also acquired the London-based fiction publisher Head of Zeus, which the company said contributed to £9mn of sales in the nine months since the deal.Newton said the company would continue to buy smaller rivals, adding that “we have several acquisitions under consideration, and they are primarily academic”.Bloomsbury said it would raise its final dividend 24 per cent to 9.40p a share. More

It’s classic ECB to call an emergency meeting six days after a regular meeting to discuss something it has already announced, having lost the thread of its argument around controlling sovereign risk even before its first rate hike of the cycle. From Bloomberg:European Central Bank officials will be invited to sign off on the reinvestment of bond purchases conducted under the now-halted pandemic emergency program, a crisis response that they flagged in their decision last week, according to people familiar with the matter. Policy makers are holding an emergency meeting starting at 11am in Frankfurt that will last about two hours as they consider how to react to a surge in Italian bond yields using the measure, the person said. They declined to be identified because such discussions are confidential. The people didn’t know if other measures might be considered by the Governing Council.This is not new? The ECB policy statement on Thursday had explicitly flagged reinvestment of PEPP bonds as a first line of crisis response:In the event of renewed market fragmentation related to the pandemic, PEPP reinvestments can be adjusted flexibly across time, asset classes and jurisdictions at any time. Net purchases under the PEPP could also be resumed, if necessary, to counter negative shocks related to the pandemic.A lack of detail about how to address the renewed rise in peripheral spreads provided the disappointment on Thursday. Today’s ad hoc meeting might offer a wider range of possibilities, though none is obviously attractive at the start of a tightening cycle. Here’s Morgan Stanley:The transmission of monetary policy relies on a clean impulse from rate hikes to borrowing costs in the euro area economy. When the ECB raises rates, borrowing costs should increase in a linear fashion in all euro area countries. If this is not the case, ie, borrowing costs are rising significantly more in some countries than in others, the ECB is faced with a situation of fragmented transmission.The president and other ECB policy-makers have declared (here and here) that they will not tolerate a fragmented transmission of ECB monetary policy and that they have all tools available to deal with such a situation. In particular, the ECB has stressed the possibility to flexibly use reinvestments under PEPP. Moreover, there have been repeated mentions of a new anti-fragmentation tool.We see three outcomes as possible going forward:Verbal intervention: The ECB could simply decide to issue a statement, similar in content to the speech yesterday from Board member Schnabel.PEPP reinvestments: The ECB could formally decide to activate PEPP reinvestment flexibility and start buying BTPs and Greek bonds. It may also announce a dedicated envelope.Anti-fragmentation tool: The ECB could decide on a new programme and announce its key features today. The programme would likely only start some days after the announcement.If fragmentation control really is limited to reinvesting proceeds from PEPP bonds into the periphery, disappointment will redouble. Really, though, what are the options? Morgan Stanley again:We think that the second scenario is most likely. Only verbal intervention seems insufficient at this stage. At the same time, the bar for enacting a new programme has likely not been reached, as the spread widening seen so far was not systemic. What’s more, PEPP reinvestments have been mentioned many times but so far not actively used, and it would appear likely to us that the ECB first exhausts this tool before embarking on an entirely new programme to control peripheral spreads. In any case, even the full allocation of PEPP reinvestments to peripheral countries would only represent a third of total gross supply. So, while announcing PEPP reinvestments may be enough for today, it’s unlikely to be fully sufficient to counter fragmentation risks.And here’s SocGen’s Kit Juckes to wax on the ECB’s current bind:Sometime between the first and second meetings, of the day, as I grabbed a cup of coffee and said good morning to my wife, she said the gods are punishing the ECB for hubris. This is the sort of thing that happens if you marry a classics teacher. The Greek gods didn’t like humans who over-stepped their mark and tried to behave like gods. The ECB’s carefully-communicated strategy was to end asset purchases, then raise rates, starting in small increments and accelerating if needed. That would allow an escape from the current extraordinary policy regime. This strategy is in all sorts of trouble today as the ECB meet to discuss their anti-fragmentation policy and tools.So far, the euro likes the news, because BTPs like it and as peripheral spreads narrow, the euro can bounce. But the need to prepare the ground to defend the Eurozone bond market highlights the ECB’s dilemma: How can you use monetary policy both to target inflation and to target bond market stability? And how can you stave off fragmentation without easing monetary conditions through additional bond purchases? If the stability of the bond market is more important than the ECB’s inflation mandate, it can stymie monetary policy normalisation, until there’s a fiscal, as opposed to a monetary solution to the euro’s Achilles Heel. More

The Federal Reserve is set to embrace an increasingly aggressive approach to monetary policy tightening as it confronts the highest inflation in four decades.During its two-day policy meeting, officials on the Federal Open Market Committee have been actively debating the merits of implementing the first 0.75 percentage point increase since 1994. An adjustment of that magnitude would lift its benchmark policy rate to a new target range of 1.50 per cent to 1.75 per cent. Their decision will be announced at 2pm Eastern time on Wednesday. The discussion marks an abrupt shift for US central bankers, who just before the start of the 12-day “blackout” period ahead of the meeting — during which policymakers are limited in their public communications — indicated broad support for a second consecutive 0.50 percentage point increase, which would have been the first such back-to-back move in nearly 30 years.The pivot comes after data released on Friday showed an unexpectedly large jump in consumer prices in May and a worrying rise in inflation expectations, suggesting that Americans are growing more concerned about the economic outlook.Losses have mounted across Wall Street as more forceful monetary policy tightening has been priced in. The S&P 500 is now more than 20 per cent below its January 2022 all-time high, a decline commonly identified as a bear market, while US government bond yields have surged to multiyear records.Two-year Treasuries, which are most sensitive to changes in the trajectory of monetary policy, are trading around 3.4 per cent, up from 2.7 per cent just days ago. In one week, the yield on the benchmark 10-year note, which serves as a benchmark for global debt markets, has shot up more than 0.45 percentage points to close in on 3.5 per cent.The Fed is also due to publish on Wednesday an updated “dot plot” mapping the individual interest rate projections of its top officials — a group that includes Lisa Cook and Philip Jefferson, who were confirmed as governors in May. The latest release in March indicated the benchmark policy rate would rise to 1.9 per cent by year end and 2.8 per cent in 2023, where it was estimated to remain through 2024. Now, officials could signal a fed funds rate of 3.5 per cent in December, which would translate to another 0.75 percentage point increase in July and a half-point adjustment in September, before moderating to more typical quarter-point increases for the final two meetings of the year. Additional increases are also expected in 2023, and officials could potentially pencil in a policy rate around 4 per cent. More officials are also likely to suggest rate cuts in 2024, reflecting the fact that the economy would have slowed considerably by that point.

Alongside the new dot plot, the Fed will publish revised economic forecasts. In March, officials estimated core inflation, which strips out volatile items such as food and energy, would settle at an annual pace of 4.1 per cent this year before falling to 2.6 per cent in 2023 and 2.3 per cent in 2024. As of April, that figure stood at 4.9 per cent. Despite substantively tighter monetary policy, the unemployment rate was not projected to rise significantly from its historically low level, steadying instead at 3.5 per cent through the end of next year, per March’s projections. The economy was also seen expanding each year by 2 per cent or more through 2024.A recent poll of leading academic economists by the Financial Times showed that nearly 70 per cent believed the US economy will tip into a recession next year, counter to what Fed officials have argued. More

Laos is struggling with acute fuel shortages, rising food prices and growing debt, making it the latest Asian country after Sri Lanka to come under serious financial strain after a surge in global energy and commodity prices.Moody’s Investor Service on Wednesday downgraded the landlocked, communist-ruled country’s sovereign debt rating one notch further into non-investment grade, or “junk” territory, to Caa3 from Caa2.The rating agency said Laos’s default risk would “remain high given very weak governance, a very high debt burden and insufficient coverage of external debt maturities” by foreign exchange reserves.“In the face of narrowing financing options, even to meet limited financing needs, Laos’s reliance on external and domestic commercial financing will increase, resulting in higher exposure to market sentiment,” Moody’s said.Laos was already having trouble paying its bills before the recent surge in global food and energy prices precipitated by Russia’s invasion of Ukraine and western countries imposing sanctions on Moscow in response. “There is pretty significant foreign exchange liquidity pressure at this point, which seems most recently to be the result of rising oil prices and what that means for the import bill,” said Jeremy Zook, lead sovereign analyst for Laos with Fitch Ratings. “Foreign exchange has become quite limited.” Fitch has rated the country triple C, meaning debt default was a possibility.Last month Sri Lanka became first Asia-Pacific country in decades to default on its foreign debt. The kip, Laos’s currency, has sunk 23.5 per cent against the US dollar this year. As of December, the latest available data, the country’s gross reserves were worth about $1.3bn, enough to cover about 2.2 months of imports, according to the World Bank. In recent weeks, social media users have published images of long queues at petrol stations and some Laotians have been crossing the border into Thailand to fuel their cars. Media in the one-party state, which operate under government censorship, have reported openly on the crisis. The Laotian Times this week reported that the country’s central bank was considering banning people from holding foreign currencies in an effort to address the liquidity crunch, and that the government was set to issue high-interest bonds to reduce the volume of cash in circulation.

Laos has borrowed heavily in recent years to fund hydropower projects and a Chinese-built railway bisecting the country that opened in December.According to the World Bank, the south-east Asian country’s public and publicly guaranteed debt rose to $14.5bn, or 88 per cent of gross domestic product in 2021, up from $12.5bn, or 68 per cent of GDP in 2019. Electricité du Laos, the power utility, accounted for more than 30 per cent of its government debt, according to the multilateral lender. Unlike Sri Lanka, which has a wide range of creditors, Laos owes about half of its debt to China, with which it shares a border, giving its financial crisis sharp geopolitical implications.Beijing has given Vientiane some debt relief in recent years, analysts said, and would probably play a leading role in any future measures. “The big unknown is what happens with China,” Zook said. Twitter: @JohnReedwrites More

Good morning. Fed day! Everyone now expects a 75 basis point interest rate increase; a week ago almost no one did. Some thoughts on how that came about, below. Send along your thoughts on Fed communications: [email protected] and [email protected] is no reason to do bad policyHere is the Federal Reserve’s policy about pre-meeting blackout periods:To facilitate the effectiveness of the committee’s policy deliberations and the clarity of its communications, participants will observe a blackout period on monetary policy communications in conjunction with each regularly scheduled committee meeting. The blackout period will begin at the start of the second Saturday (midnight) Eastern Time before the beginning of the meeting and will end at midnight Eastern Time on the next day after the meeting . . . During each blackout period, participants refrain from expressing their views about macroeconomic developments or monetary policy issues in meetings or conversations with members of the public.We have learned in recent days that almost no one on Wall Street believes the Fed followed this policy in the run-up to today’s meeting.What people believe, instead, is that the Fed really had something to say, so it called The Wall Street Journal, and The Wall Street Journal wrote a story saying that the Fed was “considering” that thing. The consensus view is that this is what happened on Monday, and that the wild moves in the market late on Monday were the direct result. (I have no hard information about this. Is it possible everyone on Wall Street is wrong about this at the same time? Weirder things have happened.)The story said that the Fed was really, really thinking about announcing a 75bp rate increase today. Here is the lead:A string of troubling inflation reports in recent days is likely to lead Federal Reserve officials to consider surprising markets with a larger-than-expected 0.75-percentage-point interest-rate increase at their meeting this week. The use of “surprising” here is of course deliciously ironic (and the sentence strictly speaking false) if the prevailing account is true and the story was a leak. Because surprising markets at their meeting is precisely what the Fed decided not to do. They wanted to give a very strong hint before the meeting, so markets wouldn’t be surprised.Two questions leap out here. One, is this all quite stupid? Does it matter if the market is shocked on Monday, by the WSJ, or today, by a Fed press release? Honestly, why bother? Two, does the hilarious, clumsy transparency of the whole ploy erode the Fed’s credibility? The Fed has prided itself on deliberate, gradual messaging. Will the Fed’s words carry less weight in the future? A Bloomberg article summed up the worry:A 75bp increase would be a communication shift for Jay Powell who has preferred to telegraph moves in advance and embrace gradualism. That strategy has allowed the Fed to lean in to tighter policy, but let markets price the risk of going faster or slower as the data rolled in.A 75bp increase could though boost credibility by showing the Fed’s serious about its inflation fight. But it also risks confusing markets about what they do next if investors know officials are willing to switch guidance . . . A 75bp move could also erode Fed credibility by underscoring how poor the Fed’s forecasting has been in the post-pandemic recovery.I think the answer to the first question is probably yes. It likely doesn’t matter when the market was surprised, given that almost everyone believes that it was the Fed that did the surprising. You could argue that the market response would have been more violent if it got the news from the Fed itself. I’m not sure, though. Monday’s moves were pretty spectacular. The headlines would have certainly read differently. On Monday we got “Treasury yields soar on concerns Federal Reserve will raise rates sharply”, whereas today we would have gotten “Fed shocks markets with larger hike”. That difference might have had political implications.Perhaps it’s dumb to have a blackout period at all. But none of this matters all that much, because the answer to the second question is no. The Fed’s credibility is not at risk here.Credibility is what the Fed has when it can make the market believe it is going to do something just by saying it will do it. Clearly, in this case, the Fed had plenty of the stuff: markets thought it was saying a 75bp increase was coming, and the market immediately priced that increase in. Credibility is a useful policy tool to have, so it is better, all things being equal, if the Fed does exactly what it says in advance it is going to do. But credibility cannot be sustained if the Fed mechanically sticks to old policies in the face of new facts. That would lead to the (true) belief that the Fed was run by nitwits. This is why Powell uses language like this, from last month:What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down — and if we don’t see that, then we’ll have to consider moving more aggressively.These are not weasel words. They are an expression of how sensible policy must work.There is another concern about the 75bp move, which is that it might lock the Fed into a series of such moves, increasing the odds that the central bank will overtighten and drive the economy into recession. Here are Krishna Guha and Peter Williams of Evercore ISI:The WSJ leak that the Fed will hike 75bp this week risks conveying a whiff of panic that the central bank thinks it is too far behind the curve, as to date there is no systematic and credible strategy behind the 75 . . . A 75bp move in June almost guarantees another 75bp move in July as little will have changed by then and risks the Fed being stuck in 75s for longer.The problem is not the idea of a catch-up level-shift in rates — we first started talking about this in late ‘21 — but the combination of big increments and an outcome-based standard for stopping raising rates that looks like a recipe for going too far and causing recession.First of all, it seems the Fed was not stuck in a rut of 50bp increases. Why would they be stuck with 75s? On top of that, Guha and Williams suggest that the Fed, in order to appear consistent, might pursue policies that are bad for the economy, and should therefore not pursue a policy that would be good for the economy without telegraphing it in a “systematic and credible strategy” — that is, saying what it is going to do, and why, in advance. But this is sort of bonkers. Credibility cannot be a justification for pursuing the wrong policy. There is a real concern embedded in what Guha and Williams write. As Skanda Amarnath of Employ America recently pointed out, inflation lags economic activity. If the Fed keeps tightening until inflation appears totally under control, it will almost certainly tighten too much. If the Fed is not responsive and nimble in both directions, credibility will be the least of its problems.One good readIn her triumphant return to FT Alphaville, Alexandra Scaggs asks why crypto exchange Coinbase had 20 times the staff of FTX, a similar-sized competitor. The tech rout, brutal though it may be, is reining in excess. More

Lenders are extending fewer loans to the car buyers with the riskiest profiles, a sign that they are bracing for an economic slowdown that could test people’s ability to pay their debts. The pullback in credit to so-called subprime borrowers comes as used-car prices remain high and record petrol prices increase the cost of driving a car. Interest rates are rising as the Federal Reserve works to contain inflation. “A whole swath of consumers are just not going to be able to get cars,” said Jennifer Thomas, a portfolio manager at Loomis Sayles. Instead, lenders are concentrating on consumers with better credit scores, a trend that can be seen in pools of auto loans that are used to back issuance of new debt through so-called asset backed securities. Global Lending Services has cut the number of loans to borrowers without a credit score to 5.6 per cent of its latest deal this month, down from closer to 8 per cent in its deal sold at the same time last year, according to data from S&P Global. The South Carolina-based lender also cut the percentage of loans to other borrowers in the lower tier of subprime credit, while it boosted the number of loans to borrowers with a credit score of more than 600. Subprime is defined differently by various data providers, but it is commonly understood as a Fico credit score of less than 620. The subprime lending arm at Santander bank has also boosted lending to borrowers with a credit score of 601 and above. It reduced the number of loans to borrowers who lack a credit score to less than 8 per cent in its latest deal this year, from more than 12 per cent for deals at the start of 2020 and the end of 2019, according to S&P. At General Motors-owned AmeriCredit, more than 13 per cent of the loans in its deal this month were to borrowers with a Fico score of 660 or higher, up from less than 3 per cent last year. Amy Martin, head of auto ABS research at rating agency S&P Global, said that there has been a similar trend across other subprime auto ABS issuers, as rising interest rates and soaring inflation are expected to put increasing pressure on consumers’ finances. “A number of issuers have told us that they are trying to be more conservative, eliminating the lowest quality buckets given that they are concerned about inflationary pressures on their customer base,” Martin said.

Used car and truck prices are outpacing inflation in the US, rising 16.1 per cent year over year to May, the government reported last week. Over the past year, the average used car loan amount surged by nearly $4,000 for deep subprime borrowers, according to Experian, with the average monthly payment rising by $78 to $425. Interest rates on loans in recent subprime ABS deals were typically around 20 per cent.“A lot of issuers have just cut off the bottom end of consumers, saying they can’t afford these cars,” said Thomas of Loomis Sayles. For outstanding loans, some borrowers are beginning to struggle to make debt payments. While overall delinquencies remain in line with seasonal trends, the number of subprime write-offs and borrowers more than 60 days past due on their payments has risen to a new record this year, according to data from Equifax. More

The mammoth task of shrinking the Federal Reserve’s $9tn balance sheet has finally begun.On Wednesday, the US central bank will stop pumping the proceeds of an initial $15bn of maturing Treasuries back into the $23tn market for US government debt, the first time it has done so since it kicked off its bond-buying programme in the early days of the coronavirus pandemic.While the Fed has flagged its plans for so-called quantitative tightening well in advance, investors are not clear what the impact will be of a process that has never been attempted at such scale before. The move could further unsettle a bond market already battered by speculation that the Fed is poised to accelerate the pace of its interest rate rises.“The Fed has been a big buyer and a big stabilising influence in the markets for a couple of years,” said Rick Rieder, chief investment officer for fixed income at BlackRock.“Losing that, with the uncertainty around inflation and growth, means that volatility in the rates market is going to be high, much higher than we witnessed over the last couple of years,” he added. The unease in financial markets challenges the Fed’s assertion that balance sheet reduction will be a dull, predictable endeavour — likened to “watching paint dry” by former chair Janet Yellen the last time the central bank embarked on the exercise in 2017.As was the case then, the Fed is allowing bonds to mature and will not reinvest the money, rather than selling them outright — a more aggressive alternative.Members of the Federal Open Market Committee in May officially agreed to cap the run-off at an initial pace of $30bn a month for Treasuries and $17.5bn for agency mortgage-backed securities, before ramping up over three months to a maximum pace of $60bn and $35bn, respectively. That translates to as much as $95bn per month.When the amount of maturing Treasuries falls below that threshold, the Fed will make up the difference by reducing its holdings of short-dated Treasury bills. Active sales of agency MBS may also eventually be considered.That is a far more aggressive plan than the last balance sheet unwind in 2017-19, which began nearly two years after the Fed lifted interest rates for the first time since the global financial crisis. That move ultimately ended in disaster: overnight lending markets seized up, suggesting the Fed had pulled too much money out of the system.As the process gets under way this time, it’s unclear exactly where the pain will be, although the Fed now has various emergency facilities in place that may help to stave off a repeat of the 2019 market mayhem.Anticipation of higher interest rates — notably after two reports in recent days indicating a growing risk that inflation will become more deeply embedded — has driven yields on Treasury bonds to their highest levels since 2007. The three major US stock indices have fallen into correction territory. Spreads on US corporate bonds are showing higher chances of default. Changes to the Fed’s main policy rate are seen as having a more direct impact on financial conditions and economic activity than quantitative tightening, but economists do expect balance sheet run-off to have an effect as well.When the Fed buys bonds, it electronically credits the seller, in turn adding reserves to the banking system that then enable banks to increase their lending to individuals and companies. By ceasing to reinvest the proceeds of its bond portfolio, the process reverses, leading to fewer reserves in the system and tighter financial conditions.In a paper published by the central bank earlier this month, researchers surmised that reducing the size of the balance sheet by roughly $2.5tn over the next few years is “roughly equivalent” to raising the federal funds rate by just over half a percentage point “on a sustained basis”. They caveated their findings with a disclosure, however, that the estimate is “associated with considerable uncertainty”. Christopher Waller, a Fed governor, has previously said the central bank’s plan to shrink its balance sheet amounts to “a couple” of quarter-point rate rises, while vice-chair Lael Brainard said in April that the process in its totality could be worth “two or three additional rate hikes”. Some analysts including Meghan Swiber at Bank of America and Edward Al-Hussainy at Columbia Threadneedle argue that the direct tightening effects of balance sheet normalisation described by top Fed officials have already been anticipated by the market and are reflected in asset prices. But the Fed’s pullback is also likely to have a secondary effect on prices as liquidity — the ease with which investors can buy and sell assets — deteriorates as markets grapple with a larger amount of bond supply to absorb. “Our understanding is that the Fed’s involvement in the market and buying Treasury securities helps improve liquidity, helps improve market functioning,” said Swiber. “And now we’re going to be in an environment where there’s more supply that needs to be taken down, and the Fed is not there to help.”

That means that the size and frequency of price swings may worsen as the Fed withdraws from the market, particularly in the Treasury market, where the central bank has had the biggest presence. But because the Treasury market is the backbone of all US financial markets, those effects ripple out. Liquidity in the Treasury market in recent weeks has been at its worst levels since March 2020 in the days before the Fed was forced to intervene and buy bonds to ease market functioning, according to a Bloomberg index that measures traders’ ability to execute deals without affecting prices. More