The financial landscape has undergone big shifts over the past couple of decades. The Federal Reserve’s Quantitative Easing (QE) program has changed how we think of the money supply. Originally started after the financial crisis, QE is here to stay. Let’s talk through the consequences of the Fed’s QE program.
What is Quantitative Easing (QE)?
QE is essentially just an aggressive form of monetary policy. The Fed will purchase securities an assets from the open market and hold them on their balance sheet. And now, they have a $3T mortgage backed securities problem on their hands.
They do this to increase the money supply and lower interest rates. The goal is to stimulate economic activity. This is especially relevant in recessions, by making borrowing cheaper and boosting investment.
The Direct Impacts of QE
Lower Interest Rates
The main goal of QE is to reduce long-term interest rates. By buying long-term securities, the Fed drives up their prices. This pushes down their yields. Lower rates usually spur borrowing and investing.
The Federal Reserve purchases long-term securities in vast quantities. This demand surge translates to an uptick in these securities’ market prices.
As the price of a bond or security rises, its yield drops. The increased demand and rise in the price mean their yields decrease.
Economic Stimulation: The lowered interest rates have broader economic implications:
- Business Growth: Companies have cheaper credit. This leads to business expansions, acquisitions, and hiring.
- Consumer Spending: Lower interest rates mean lower mortgage rates and cheaper auto loans. This translates to more consumer spending.
- Investment Landscape: With fixed incomes providing lower yields, investors will move their funds to riskier assets, in order to try for better returns.
Increased Asset Prices Drive Bulls to Stocks
The QE program floods the financial system with money. This increases the available capital looking for investment opportunities. Lower interest rates makes alternative investments less attractive.
Investors move away from bonds and into stocks. This demand pumps stock prices higher. Valuations can become stretched, which leads to bubble concerns.
Devaluation of Currency
Quantitative Easing has impacts foreign exchange and currency markets. This is because it directly impacts the money supply.
QE increases the money supply (see above). This typically boosts economic activity, but also devalues currency.
A weaker domestic currency has a silver lining: it can make domestically-produced goods and services more affordable for foreign buyers.
It’s worth noting that while currency devaluation can boost exports, if multiple countries are engaged in similar monetary easing policies, it can lead to a “race to the bottom. Each country will try to devalue its currency more than the others to gain a trade advantage.
