How do different markets respond to QE programmes?
The announcements of new bond buying programmes by the European Central Bank and the Federal Reserve have lit a fire under stocks and commodities.
The twin announcements by the ECB and Federal Researve have sent bears running to cover short positions and encouraged those who had been sitting on the sidelines through the summer to put their capital back to work.
These changes have sent stocks and commodities soaring, while putting the dollar and treasuries under pressure. The main question now being asked is whether the big moves of early September have already priced in the quantitative easing (QE) effect or if there is more room to run?
QE programmes are intended to lower interest rates and get the economy growing by increasing the supply of money in the financial system. Because it takes time to start up new projects on Main Street, it comes as no surprise that, initially, the new money printed often finds its way on to Wall Street first.
For stocks though it has taken some time for markets to respond to QE. The reason for this is that QE is an emergency measure brought in to boost a faltering economy because interest rate cuts have stopped working. QE has been introduced at a time when the outlook for corporate earnings is bleak and stock markets are depressed. It can take some time for attitudes to change.
So far, the third round of QE is different from the other Federal Reserve programmes of recent years. QE1, QE2, and Operation Twist were all introduced when stocks were falling. QE3 arrives at a time when stocks have been rising. Similarly, previously it took a month or more for the effects of QE to take hold. This time around the reaction was immediate and strong. This leaves many to wonder if the response has been front-loaded this time and what may be left on the table in terms of potential gains.
The US is not the only country that has been using QE to try to boost its economy in recent years. The Bank of England has also been steadily increasing the amount of QE in the system over the past several years.
Generally speaking, as time has progressed, the positive impact of QE on the UK economy has decreased. Although the numbers picked up on the back of the Monetary Policy Committee’s latest move, results may have been distorted by the impact of the London Olympics and may not be due to monetary policy changes. QE has tended to have a larger impact on the construction sector than the manufacturing or service sectors.
Other central banks have also been adding liquidity at similar times, and it’s possible that programs from the Fed or others may be having a larger impact on markets. For example, a big US QE programme could depress the dollar more than the UK programme depresses sterling, pushing it higher over that period.
The one trend that does come through clear is that QE has had a smaller effect on the economy over time, raising questions of whether future increases would do more to boost business or boost inflation.
Colin Cieszynski is senior market analyst at CMC Markets