Does QE2 = Y2K?

There is quite a bit of fearful angst being expressed about the looming end of QE2 and the damage it may inflict on interest rates, stock prices, the housing market and the economy. It reminds me of the fear in anticipation of Y2K more than a decade ago. Like that overwrought, hyped non-event, QE2 is likely to pass quietly into the night.

 

The end of QE2 has been anticipated since QE2 was first announced several months ago. QE2 was implemented because the slow pace of economic growth was generating new job growth too slowly to bring down unemployment at a satisfactory pace. Implicitly, QE3 was highly unlikely unless QE2 proved unsuccessful. And if QE2 proved a rousing success, there was certainly a possibility that it could be terminated early. But by far, the likeliest outcome was that QE2 would contribute modestly to the recovery and it would end, as scheduled, at the end of June. With a definite end date, market participants had every opportunity to monitor its progress and prepare for the end of Fed buying of market securities. There are no surprises here.

 

Indeed, corporate treasurers have been issuing new debt at an accelerated rate, taking advantage of the Fed’s heavy buying freeing up cash in the debt market, while locking up cheap financing under the most favorable terms imaginable. Companies that do not need cash have been issuing bonds, if only because they can’t turn down really cheap money. So, bond issuance has been very strong, a substantial offset to the buying by the Fed. Companies are likely to reduce their bond issuance when the Fed stops buying, softening even further any minimal impact on market interest rates.

 

QE2’s impact on interest rates is unclear, but I’m fairly convinced it is minor. Some Fed officials suggested that each $200 billion of buying may be the equivalent of a 25 basis point reduction in the funds rate, although interest rates rose after the QE2 started, contrary to expectations, as incoming data suggested that the pace of economic activity was picking up. Contrary to the predictions of the fear mongers, rates are falling as QE2 nears its end, because growth has slowed, at least temporarily, in response to higher energy costs and more financial turmoil in European credit markets pushing investors into safer assets. It is not surprising that economic developments have far more powerful effects on rates than the Fed’s QE program. It is my judgment, one that I share with the majority of viewpoints expressed at the Boston Fed Conference on monetary policy, that QE2 was never likely to have a sizable effect on markets.