Now that it's ending, what did QE do? (No one is quite sure)
The Federal Reserve has another monetary policy meeting this week. It ends on Wednesday, which is when we'll get the verdict on where interest rates are heading.
But more importantly, we'll get an idea of when quantitative tightening (QT) is going to end. And we'll also get an idea of exactly how that process will work.
QT is the opposite of quantitative easing (QE). QE is loosely but accurately described as money printing. It's what the Fed, and most other central banks, have been doing since the financial crisis.
The central bank creates money. It uses this money to buy assets, mostly government bonds (although if you're the Bank of Japan, you've already run out of those and you are moving on to chunks of companies. And when you run out of those, you have to wonder what's next. A topic for another day perhaps).
When the central banks started doing QE, no one could quite agree on what the effect would be. The scenarios ranged from hyperinflation (I will not deny that I was close to that side of the argument for a while) to absolutely nothing at all.
Now that it's been running for ten years or so, the range of scenarios has narrowed. But people still can't really entirely agree on what it did.
It didn't cause hyperinflation (yet!). And it almost certainly did "something". And most people would probably agree that it helped to push up asset prices, although they still disagree on the precise mechanism.
I'd argue that it benefited the wealthy (those who own stuff) at the expense of the less wealthy (those who rely mainly on income and savings) via quite a few mechanisms the stifling of competitive pressure being the main one.
But we could argue the toss on that one for years it's a highly politicised argument. It's not quite at Brexit levels of partisanship, but it's not far off it. So good luck on getting sense out of a neutral observer on the topic.
Anyway. You've had global central banks creating money and pumping it into markets for years. To me, there's no doubt that this must have pushed up asset prices.
The question really, is this: did the central banks merely step in to provide demand when the rest of the world was too scared to invest? Because if that's the case, then the argument is that central banks can pull back without too much effect, because they will be replaced by natural demand from investors.
How lucky does the Fed feel?
That's not an easy question to answer. Markets aren't mechanical things. It's an incredibly seductive mental model, the analogy of market as a machine (and it can be useful in some circumstances and with the right caveats). But if you're not careful it will lead you up the garden path.
Perhaps the best way to look at QE is the idea that central banks have provided a security blanket for markets. That made everyone take more risk than they were prepared to take because they knew that central banks had their back.
Every time that central banks have tried to withdraw that security blanket, markets have suffered from a fit of the vapours. For example, you had the "taper tantrum" when Ben Bernanke first talked about reducing the rate of QE. You then had another panic when Janet Yellen, his successor, was talking about raising interest rates in 2015.
Now markets have had another bout of nerves amid Jerome Powell's interest-rate rises. Can this be reversed too?
The reality is that, so far, it seems that it already is. Markets have rebounded following Powell's U-turn at the start of the year.
What they probably need now is for the Fed to come out and be even more dovish than investors currently expect. Whether Powell is willing to do that, or has instead suffered from a bit of remorse and would like to test the market again, is the big question.
My feeling is that he has now fully bought in to the message of easy money, and that as a result, he'll probably try to keep the market happy. That means that we'll probably get a decision that has the Fed either ending QT much earlier than expected, or continuing in a manner which involves getting rid of its mortgage-backed debt, but buying up government bonds to replace that debt.
If we don't get that sort of surprise if the Fed comes out more aggressively than expected then I'd expect to see a big drop in markets. I think that's highly unlikely.
The harder question to answer is whether a more relaxed Fed can keep markets rising. For that, I think the real economy might have to demonstrate a little more proof that we're not heading for recession imminently.
In the meantime, the usual message applies: US stocks look pretty expensive; most other markets look relatively cheap, particularly the UK (if you're looking at developed markets). So don't you fret too much over the Fed if you buy markets that are inexpensive, you don't have to rely on the vagaries of central banking to make sure you generate a decent return over the long run.
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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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