To be very clear, this blog is an oversimplification of a very complex issue. Despite that fact, the premise is pretty straightforward. Global central bankers buy bonds on open markets and this is called quantitative easing (QE). In my view this tactic tries to push bond yields lower while expanding their own balance sheets in the process. Simply stated, the central bank in question is basically printing money (a term I’m using loosely here) to purchase bonds.
Quantitative Easing Strategy
If markets know a central bank is buying bonds each month for an extended period of time, traders generally join in the game. This in turn pushes rates lower. A primary theme in the world of central banking is that low interest rates help stimulate a country’s economy. (Oops, I meant to say increase employment and inflation.)
The QE game has been going on for many years, and analysts still debate its effectiveness. Many argue that QE hasn’t stimulated economies. However, QE has caused interest rates around the world to fall. (An example is where approximately one-third of all government bonds in the world traded with a negative yield.) So, there can be little question that quantitative easing does cause rates to fall.
From an economic standpoint, it’s unclear if QE actually stimulates an economy. The party line from central bankers contends things would have been MUCH worse QE schemes hadn’t been implemented.
The Bottom Line
The bottom line is that a QE scheme effectively creates new capital in the markets. The central bank buys bonds on the open market. The seller, primarily big banks, receives money from the sale and needs to reinvest it. This is fresh capital created by QE, and it has to go somewhere.
The Key Point
While the jury is still out on whether QE really works from an economic standpoint, it DOES create capital. And a fundamental rule of markets is “money goes where it is treated best.”
Since the credit crisis ended, traders have learned a fair amount of fresh capital created by QE winds up in the U.S. stock and bond markets. The important thing is a great deal of that new money apparently winds up in our markets. This is especially true when prices go are going down.
Each and every decline seen in the U.S. stock market over the past several years was reversed in short order. This is because traders know QE money is coming, and they want to get in front of this event.
We have fresh capital that has to go somewhere. If interest rates are too low to be a save haven’t, the fresh capital goes to equity markets. You will most likely see more volatility with faster declines and faster recoveries.
But, what do I know? This is how I see it and is my opinion. Just thought you might like to know.