Fed’s first hurdle in 2020: Dispensing with ‘QE Lite’
The Federal Reserve’s bond portfolio is swelling again at a pace not seen since the “quantitative easing” heyday in the early 2010s. Prices for stocks and other risky assets are also rising at a fast clip - a state of affairs that a growing chorus of investors, economists and former Fed officials say is no coincidence, and potentially a problem.
Since the Fed started buying $60 billion of Treasury bills a month last fall to counter ructions on short-term money markets, credit spreads are tighter and the bank funding markets targeted by the purchases are calmer. Financial stress measures tracked by regional Fed banks are at their lowest in a year or more - all signs of the program’s success.
The S&P 500 also is up more than 10% since October.
It all sets the stage for the first tricky maneuver the Fed will undertake this year: turning off the tap. A misstep could have painful consequences.
“The risk is what happens when the Fed stops increasing their balance sheet,” said Peter Boockvar, chief investment officer with Bleakley Advisory Group. “What will stocks do when that liquidity spigot stops? We’ll have to see.”
In the wake of the financial crisis of 2007-2009, the central bank acquired a vast portfolio of Treasuries and mortgage-backed securities - topping $4.5 trillion at its peak - through three operations known as quantitative easing, or QE.
While designed to help lift the economy after the crisis by holding down long-term interest rates, QE also had a side-effect that appears to be replaying now: Prices for risky assets like stocks and low-quality corporate bonds rose as the Fed’s portfolio grew.
‘QE LITE’
Fed Chair Jerome Powell and other policymakers have asserted their latest balance sheet expansion is a technical adjustment and not stimulus. “Our Treasury bill purchases should not be confused with the large-scale asset purchase programs that we deployed after the financial crisis,” Powell said after October’s policy meeting.
Many market watchers aren’t buying it, and several have dubbed it “QE Lite.”
“You can debate it all you want, but as long as the flows are increasing the size of the balance sheet, stocks are going to rise in price,” said Danielle Dimartino Booth, founder of Quill Intelligence, a boutique research firm, and a past adviser to former Dallas Fed President Richard Fisher.
Fisher, who ran the Dallas Fed from 2005 to 2015, said the influence on markets could be driven mainly by expectations created during earlier rounds of QE, which corresponded with hefty stock market gains.