Commentary-Quantitative Easing-Print

The Fed liked QE so much, they continued the process through 2014. And in hindsight, it would certainly appear to have helped our recovery along. We’ve had eight years of expansion since the end of the Great Recession, and it’s hard to quarrel with QE’s positive impact. At least that is from those borrowers’ or investors’ perspective who were able to take advantage of these ultra-low interest rates, refinance their loans, hold onto their businesses and houses and watch their financial assets grow again. But of course, there is no absolutely free lunch. Risk averse savers saw their money market and CD rates collapse, and bond investors earned the smallest coupon payments ever. And of course the Fed’s balance sheet remains bloated as it grew from $1 trillion to roughly $4.5 trillion today. And that’s a lot of fixed rate bonds to finance with short-term deposits now that rates are slowly starting to rise. So as a good steward, the Fed is about to start to reverse what was set in place while we are healthy enough to withstand this dose of possibly bad-tasting medicine. While it is hard to prove conclusively how much all this additional bond buying lowered longer-term rates, Fed studies think it was likely in the neighborhood of 1% or so. Now the Fed wants to go in reverse – and has suggested it wants to reduce its $4.5 trillion stockpile of bonds down to about $2 trillion. And rather than an outright sale of securities, the Fed plans to shrink its stockpile of assets simply by not replacing bonds as they mature. So where does the money go once these bonds mature? Here is the dark art of monetary policy. Amazingly it will simply vanish into thin air, exactly the opposite of how it was conjured up in the first place, in effect reducing the money supply. While people always talk about the government having the capability to “print money,” this is a rare example of its ability to metaphorically burn it as well. Increasing the overall supply of government bonds on the open market should have some very real effects – namely longer-term interest rates should continue to move modestly upward. And this of course is where Yellen hopes that the process will unwind so slowly,so smoothly and take so long that it will be relatively unnoticeable, or like “watching paint dry.” Can they do it? We believe the economic recovery has enough steam and momentum to last for quite a while. Expansions simply don’t die of old age, but usually of some shock or rapid rise in inflation that forces the Fed to raise rates aggressively. None of that is in place today, with inflation low and what appears to be a relatively unobstructed runway to continue our slow but steady lift off. So let the painting begin at the Fed. And while they are at it, let’s also take a moment to say “Happy Birthday” to our economic expansion that just marked its July 1st eighth anniversary. As QE ends, blow out those birthday candles and wish our recovery a long life and a strong future to afford the Fed time to wean us all off the “Quantitative” elixir we’ve grown accustomed to consuming.

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