"Markets are not the economy" is a frequently cited mantra and it holds particularly true during periods of quantitative easing. While central banks have tightened monetary policy by raising interest rates and trimming their balance sheets, the journey to tightened financial conditions has not been linear.
From the Bank of Japan maintaining its yield curve control programme, to the Bank of China injecting liquidity in response to the Covid-induced lockdown, and the Fed and the Swiss National Bank extending emergency loans to banks, effectively counteracting the effects of much of the quantitative tightening. It is hardly surprising that markets have largely disregarded rate hikes and deteriorating economic indicators fuelling a risk rally that has caused credit spreads to steadily tighten. However, it is important to note that central banks were not the sole providers of liquidity. The ongoing debate around the debt ceiling has unintentionally triggered a sort of stealth quantitative easing as the US Treasury found itself unable to issue new debt on the scale required. Now that the debt ceiling is likely to be suspended, we expect this process to reverse. Reflecting on the previous debt ceiling discourse in 2011, a sharp depreciation in risky assets followed the resolution, while interest rates fell. The outcome could be similar this time.
