What the End of QE Means
Today the US Federal Reserve Bank (Fed) is “printing” money and using it to purchasing $85B per month in US government debt and US mortgage debt – dubbed “quantitative easing” or QE. This has had the effect of driving down interest rates and causing global stock markets to soar.
To date, the Fed has bought nearly $3.5T in debt, now holding 30.86% of all US debt.
After months of hinting at “tapering” this massive QE program, Chairman Bernanke made it very clear last month they would likely begin tapering in 2013, and end QE entirely in the first half of 2014. Here is what he said (article):
“If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year,” Bernanke said at a press conference in Washington. “And if the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”
Bernanke’s statement made it clear the Fed will begin slowing QE this year. The markets reacted violently to Bernanke’s announcement. Previously they had said they would keep QE in place until unemployment reached 6.5%. Today the unemployment rate is 7.6%, and it will take at least 12-18 months to reach that range, which is why his statement took me by surprise as it did almost everyone else.
Nearly every market reacted sharply as investors began rotating assets in preparation for a non-QE world. Interest rates rocketed up; 10-year interest rates have risen a full percentage point in just 2 months:
Municipal bonds crashed, dropping over 20% since May:
The stock markets plunged:
And gold took another dive:
Immediately, Fed members began hitting the airwaves to communicate that Bernanke had been “misunderstood,” and that the Fed would do whatever was necessary to keep the economy recovering.
Point #1: The economy is unlikely to strengthen as much as the Fed thinks it will.
Bernanke made it clear in his statement that tapering QE would be dependent upon the strength of the US economy. The Fed is clearly anticipating the economy accelerating strongly and unemployment dropping significantly this year.
But the Fed has a well-documented history of overestimating economic strength (article). In the chart below, you can see the Fed’s economic projections for 2011, 2012, 2013, and 2014 have been revised lower and lower in each subsequent quarter:
The Fed’s unemployment projections are not much better. They have had to revise their projections lower every quarter since 2011:
There is a significant possibility the Fed is again too optimistic, and the economy will not accelerate as projected – in which case the taper will be postponed. Given the contraction in the European economy and the slowing of growth in China, a sluggish US economy is quite likely.
Point #2: Tapering Will not Slow QE as much as People Think
Assuming QE tapering does begin in 2013, it will still continue its massive impact. This next chart shows the cumulative size of the Fed’s purchases with (solid line) and without (dashed line) tapering:
While significant, it certainly is not a reversal of policy.
Point #3: QE Continues Apace Elsewhere
While the Fed’s QE program is the world’s largest, the central banks of Japan, England, Europe and Switzerland still have massive QE programs in place:
Even as the Fed slows its QE program, Japan and the UK’s programs are set to continue on a massive scale. And while the ECB’s program is not growing today, the problems in Europe are mounting, and another massive QE program is inevitable in my view.
Point #4: Slowing QE is not the end of Easing
Even if the Fed does taper, it amounts to the Fed easing up on the accelerator pedal, not putting on the brakes. They have made it clear they are not talking about raising interest rates (now near zero percent) any time in the next two years.
What to Expect from Here
In spite of Bernanke’s speech, we have not yet seen the end of global QE. But we did get a clear picture how the end of QE will affect investment markets. Last month wrote, “When the QE program does end, you will want to be out of both the stock market and the bond market.” That was clearly demonstrated by the reaction of the global markets.
But with the end of QE now within sight, investors will begin a massive rotation in investments. This is why the markets moved so dramatically on the Fed’s announcement. Investors crowded on one side of the boat suddenly moved to the other, rocking the boat. At risk are both the stocks and bonds. Usually stocks and bonds move in opposite directions, but not in a QE-world.
Stocks blazed new highs on the back of the huge QE programs:
Bonds too made huge gains on the back of the Fed’s easy-money policy, but are now clearly reversing.
As QE ends, there will be “no place to hide” – most investment assets will go down.
Robert Fraser founded an e-commerce provider for business customers, including Xerox, Chase Manhattan Bank, and Samsung. He raised $44 million in investment capital and guided the company to an average of 20 percent month-to-month revenue growth over 6 years, becoming the Kansas City metro area’s fastest growing company between 1997 and 1999. In 2000, Fraser received the Midwest Region Ernst and Young Entrepreneur of the Year Award. Today Fraser is Director of Joseph International, a ministry dedicated to restoring a vision for the marketplace.
For more information or to receive Fraser’s FREE economic newsletter, visit www.josephinternational.org and click “Joseph Insight”.