Federal Reserve chairperson Janet Yellen finally pulled the plug on what many believed was the global markets’ lifeline. However, markets did not react in the way they were expected to. This is mainly because what Fed had done was already known and priced in by the markets. In fact, if Yellen would have delayed pulling the plug market would have taken it negatively believing that the central bank was not sure of the stability of the US economy.
End of quantitative easing (QE) has been described by The Guardian as an end of an era. It’s time to look back and write an obituary of QE and how it impacted our lives.
Market analysts, economists and researchers have been divided on the utility of QE over the years; however, there has been unanimity on the fact that QE has been the main reason that markets stabilized post the 2008 financial crisis. Those who lived through the worst period of 2008, especially in the financial world, believe QE was a life saver.
The US central bank had employed three rounds of bond buying programs since the crisis; the first one was to provide stability in the markets and the latter two to spur growth. Benefit for the first round of QE is apparent, but the jury is still out there on the other two.
November 2008 brought us as close to a financial doomsday as has been possible in recent times. In earlier instances, Fed used to play with interest rates to control financial shocks. But with interest rates already at near zero levels -- thanks to earlier Fed chief Alan Greenspan policy of ‘fixing’ a bubble by creating a bigger one – then Fed chief Ben Bernanke adopted a new policy of infusing money and restoring trust, since both were in short supply at the time.
QE worked as a drug that gave markets a new high, literally speaking. Dow Jones has moved up by around 80% from its lows in early 2009. But the rest of the economy did not benefit from the burst of liquidity. Most of the money was again utilised to purchase government bonds. Pumping in money in the system has resulted in Fed’s balance sheet swelling from $870 billion to $4.5 trillion. Thanks to the near zero interest rate scenario, the US has not yet felt the burden of servicing this huge baggage.
While the actual cost of QE will hit the economy after interest rates start looking up, its benefits are mixed, depending on which side you are on.
Proponents of QE say that it has hugely benefited the economy and point out at the sharp fall in unemployment rate which reached a peak of 10% in October 2009 to the recent 5.9% – the lowest since August 2008.
But opponents argue that this is because millions of American have left the job market and are no longer actively looking for employment. Labour participation rate has fallen to 1970s levels showing that the economy is still underperforming. Further, there are still many people working on a part-time basis and have not participated in the survey. Long term employment continues to be a problem.
Inflation is another area that has generated controversy. While those in favour of QE point out that inflation has not picked up despite of such high levels of liquidity, those opposing it point out that there has been no growth and pick-up in demand to warrant higher inflation. Ironically, former Fed chief Alan Greenspan, commenting on the role of QE on the economy has been quoted in the Wall Street Journal as saying “Effective demand is dead in the water” and the effort to boost it via bond buying “has not worked.”
Now that QE is no longer with us, what is the way ahead? ICICI Bank Global Market team has come out with a report on the development saying that the labour market commentary of the Fed chief is slightly hawkish. Unemployment numbers will thus continue to decide the direction of the market going forward.
But the biggest thing to watch out for is when the Fed will decide to rewind its QE. Presently the Fed has merely stopped pumping in money in the system. It is not calling on the money which it has distributed in earlier years. In their statement Fed has said that “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”
While the Fed has been brave enough to withdraw QE it is still not courageous enough to recall its money. In that sense QE is not really over as the Fed will reinvest the principle from its maturing securities. The borrower, for the time being need not be worried about replaying the money but can rollover his liability by paying interest (which is at near zero levels).
The real impact of QE on the markets will be when Fed decides to recall its money. It is then that money will start flowing out of the system. Till then markets can rejoice on the QEs initiated by Japan and a mini version initiated in the Euro Zone.
It is only when the QE is reversed that we will know if Greenspan was right. He observed that history shows central banks can only prick bubbles at great economic cost. “It’s only by bringing the economy down can you burst the bubble,” and that was a step he wasn’t willing to take while helming the Fed.
Reversing the QE would mean raising interest rates. “Recent episodes in which Fed officials hinted at a shift toward higher interest rates have unleashed significant volatility in markets, so there is no reason to suspect that the actual process of boosting rates would be any different, Greenspan said.
While the QE era might be over, post-era clean-up will determine the actual cost of QE. Delaying reversing QE and rolling over the current debt is in a way continuing QE.
