The End of Quantitative Easing (QE)
Citing improvements in the economy and employment numbers, the Federal Reserve on Wednesday took the widely expected step of ending purchases of bonds and mortgage-backed securities. However, the Fed will continue to keep benchmark interest rates at their current near-zero level for now.
Most economic news supports the Fed’s thesis. Since the last round of bond-buying (QE3) began in 2012, the unemployment rate has dropped from an August 2010 peak of 9.6% to the current 5.9%, and GDP growth has improved from 2.5% (Q4 2012) to having four out of the last five quarters at 3.5% or higher. Stocks have increased (the Dow is up by a factor of over 2.5 since the low point in early 2009), and consumer confidence has increased – although retail sales and consumer spending have taken a dip in the last month.
Did Quantitative Easing Work?
Consider two of the major reasons the QE program began – the Fed had no more room to drop interest rates for economic stimulus without going into negative territory, and the large amount of toxic mortgage-backed securities put the banking system in a crisis of confidence.
The original QE1 program was aimed as much at stability of the banking system as it was at economic stimulus. In that regard, it certainly succeeded. The overall lack of stimulus effect and deflationary concerns led to QE2 in November 2010, followed by QE3 in September 2012.
The cumulative effect of the three QE programs was to pump massive amounts of money into the banking system – where much of it still sits. $3.9 trillion worth of Fed purchases raised their overall bond holdings to $4.5 trillion. Meanwhile, bank reserves rose from $800 billion to $2.7 trillion.
Banks are acting as a bottleneck keeping the money from flowing rapidly to businesses, homeowners, and consumers – but should this be a surprise?
Penalties applied to banks and regulations have tightened credit to the point where the Obama administration is now working toward loosening credit for potential homebuyers. Wages are still flat, and while job increases have helped to increase consumer confidence, the demand is nowhere near matching the available funds that banks have for expansion lending. Most economic incentives tilt toward banks hanging on to their money.
Meanwhile, the two major arguments against QE – inflation and a falling dollar – did not come to pass. Inflation remains near the 2% target of a healthy economy, and the trade weighted dollar index is almost exactly where it was at the beginning of 2009. Critics did not foresee that the U.S. economy, while recovering quite slowly, would still outpace other world economies – making the dollar and Treasuries a good deal globally.
Overall, most analysts agree that QE met most of its goals and succeeded in its purpose, although its efficiency can be argued. Like a quarterback in football (or perhaps, the President of the United States), the Fed may be getting too much credit for positive outcomes and too much blame for negative ones.
Could Quantitative Easing Return?
If the Fed decides that three stages of quantitative easing were not sufficient and revives the bond-buying program, it won’t be anytime soon. The Fed will not rule out another stimulus but will be reluctant to start one, and with good reason.
At some point, the Fed needs to bleed almost $4 trillion worth of bonds back into the market. This cannot be done rapidly without causing huge bond market disruptions – it may take even longer to sell them than the six years it took to accumulate them. Adding more bonds just prolongs the task.
For all the fuss about the effects of the QE programs, the post-QE world is probably going to look a lot like the last few months. The Fed shows no signs of raising the short-term rates anytime sooner than next year, and it would not be a huge surprise if it takes longer than that.
Meanwhile, the Fed will eventually bleed the bonds slowly into the system, probably by not reinvesting them as they mature – but they certainly are not going to dump them in large increments.
Stocks are likely to maintain their generally upward trend, as both economic growth and corporate earnings have been strong the past two quarters. That said, expect some volatility as everyone waits for the inevitable Fed actions.
Since the dollar survived the influx of QE funds without falling, it stands to reason it probably won’t fall now, and it may potentially rise depending on the length of the economic slowdowns in the rest of the world.
In short, don’t expect much to change in the short term. If things do change, it will probably not be because of the end of QE3.