I’ve been watching for a ‘buy the rumor sell the news’ ‘risk off’ reversal, but it happened at best only momentarily after the Fed announcement, when the 10 year tsy note dipped to maybe 2.62 very briefly, stocks dipped, the dollar sort of held, gold was off a touch, etc. But now it looks like it’s ‘risk back on’ with a vengeance as both believers in QE and those who believe others believe in QE are piling on.

The fact remains that QE does nothing apart from alter the term structure of rates.

There are no ‘quantity’ effects, though from the following article and market reactions much of the world still believes there are substantial quantity effects.

And what we are seeing are the effects of ongoing portfolio shifting and trading based on the false notions about QE.

To review,

QE is not ‘money printing’ of any consequence. It just alters the duration of outstanding govt liabilities which alters the term structure of risk free rates.

QE removes some interest income from the economy which the Fed turns over to the Tsy. This works against ‘earnings’ in general.

QE alters the discount rates that price assets, helping valuations.

Japan has done enough QE to keep 10 year jgb’s below 1%, without triggering inflation or supporting aggregate demand in any meaningful way. Japan’s economy remains relatively flat, even with substantial net exports, which help domestic demand, a policy to which we are now aspiring.

QE does not increase commodity consumption or oil consumption.

QE does not provide liquidity for the rest of the world.

QE does cause a lot of portfolio shifting which one way or another is functionally ‘getting short the dollar’

This is much like what happened when panicked money paid up to move out of the euro, driving it briefly down to 118, if I recall correctly.

No telling how long this QE ride will last.

What’s reasonably certain is the Fed will do what it can to keep rates low until it looks like it’s meeting at least one of its dual mandates.

Asians Gird for Bubble Threat, Criticize Fed Move

By Michael Heath

November 4 Bloomberg) — Asia-Pacific officials are preparing
for stronger currencies and asset-price inflation as they blamed
the U.S. Federal Reserve’s expanded monetary stimulus for
threatening to escalate an inflow of capital into the region.

Chinese central bank adviser Xia Bin said Fed quantitative
easing is “uncontrolled” money printing,
and Japan’s Prime
Minister Naoto Kan cited the U.S. pursuing a “weak-dollar
The Hong Kong Monetary Authority warned the city’s
property prices could surge and Malaysia’s central bank chief
said nations are prepared to act jointly on capital flows.

“Extra liquidity due to quantitative easing will spill
into Asian markets,”
said Patrick Bennett, a Hong Kong-based
strategist at Standard Bank Group Ltd. “It will put increased
pressure on all currencies to appreciate, the yuan in particular

has been appreciating at a slower rate than others.”

The International Monetary Fund last month urged Asia-
Pacific nations to withdraw policy stimulus to head off asset-
price pressures, as their world-leading economies draw capital
because of low interest rates in the U.S. and other advanced
countries. Today’s reactions of regional policy makers reflect
the international ramifications of the Fed’s decision yesterday
to inject $600 billion into the U.S. economy.

21 Responses

  1. “The fact remains that QE does nothing apart from alter the term structure of rates.”

    And it’s not even clear that it does that given that the Fed is targeting quantities and not prices, right? Cullen at pragcap.com (who has featured articles from you in the past) has been showing that there has been no discernible impact on rates (they went up as much as down) resulting from QE in the UK, US, or Japan. Which seems logical because the increased bid in place from the Fed can easily be offset by increased eagerness to sell by “fundamental value” investors who think the price is high enough and it’s time to shift their portfolios.

  2. “QE does not provide liquidity for the rest of the world.”

    When dollars pile into emerging markets in search of higher yields, you don’t consider that to be liquidity? Have you seen at the US inflows into emerging market funds lately? Stagering.

  3. A couple of QE Questions:

    1. If one accepts the premise that humans are susceptible to herding types of behavior and thus have a propensity to, en masse, behave irrationally, is it fair to argue that one of the greatest risks of QE comes NOT from its operational monetary realities, but from the global perception that purposeful, Fed-driven dollar devaluation will wreak havoc on overseas economies?

    2. If in fact the perception exists that QEII is purposefully meant to devalue the dollar, won’t investments at least in some part leave dollar-denominated financial assets in lieu of commodities? AND, if this is true, wouldn’t this result in higher costs for goods and services tied to these commodities? AND, how might such higher costs be absorbed by the majority of Americans on fixed incomes?


  4. and the IMF’s role in this? Brute force without nuance is worse than no intelligence at all!

    “The International Monetary Fund last month urged Asia-Pacific nations to withdraw policy stimulus to head off asset-price pressures”
    ?? Have you seen any populations in danger of becoming too much more than what they could be?

    Coddled idiots in multiple countries are triggering a financial WWIII by expressing levels of insular ignorance not seen since WWI. This is really unbelievable.

    It’s basically a conflict between population-wide hoarding behavior and the urge to explore options. We’re failing to find ways to hoard less and build more exploratory intelligence. Call it a “big finance” lobby, or class warfare, but it’s really more fundamental than that.

  5. I wonder about the ‘removal of income’ line. Surely in any correct pricing the bonds will be removed from the economy at a slightly higher rate than they otherwise would sit at – due to the extra buyer at the table.

    Wouldn’t that boost just be the discounted cash flow capitalisation of the income stream eliminated by the Fed purchase?

    1. yes, some.

      I was writing about the actual net coupon interest the fed earns and turns over to the tsy.

      think of it this way- the fed buying secs is functionally equiv to the tsy not issuing them in the first place.

      charles goodhart has been making this point to the boe for a while with no results

      1. Great point about the similarity of fed purchasing and Treasury never issuing. It is just cash into the economy from the government with no interest payments to anyone.

        I think this method does leave open the potential of selling the Treasuries they bought in a way that the Treasury just spending and issuing debt later does not.

        The effect is nearly identical – but the perception difference is gigantic.

        Additionally, we MMT’ers know that only the level of deficit spending makes a real difference, but lets face it – “Animal Spirits” make a difference in the world, and not just in the level of entrepunrial(sic – where is that spell checker?) activity.

      2. ‘cash into the economy’ does earn interest as interest is paid on reserves now.
        which has to be the case if the fed wants to support the fed funds rate at any target rate above 0

        only the actual paper money doesn’t earn interest.

  6. “QE removes some interest income from the economy which the Fed turns over to the Tsy.”

    That’s the only direct effect. It may be the case that current portfolio shifting is based on false anticipation, but the removal of interest income at the micro level is what induces portfolio managers to shift into higher risk when they eventually decide to pull the trigger on selling treasuries.

    That’s about as distant an effect on unemployment as one might imagine.

    The CB should at least be less independent at the zero bound.

    1. Isn’t this just a secondary level effect from the level of deficit spending anyway? At these low levels, any interest payments are swamped by plain old spending.

  7. “That’s the only direct effect.”

    Such limited thinking… C’mon, it’s World Rally Day!!! 😀


    I also laughed at a comment at pragcap. Comment: “It seems great that this is working so far, but the fact that it is working is more frightening than the idea that it does not work.” TPC’s response: “That might be the best comment on QE I’ve ever read.”

    Slightly surreal.

      1. Wow, quite a statistic. If so perhaps they waited til after their welcome-to-gridlock post-election celebrations to call their brokers and go all in.

      2. JKH,

        The figures quoted in the article are wrong. Google around for the error made by the social security administration. There were two fraudulent W-2s included in the data that showed incomes of approximately $30B each.

  8. Warren: “Japan has done enough QE to keep 10 year jgb’s below 1%…”

    Without a price peg by Japan’s central bank, I still see their QE and yields as largely unrelated, FWIW. Japan’s REAL 10-year government yield is currently in the 1.5-2% range and the US in the 1-1.5% range (Japan’s YoY inflation is still negative). Admittedly that’s comparing year-on-year backward looking inflation rates to ten year forward looking yields, and inflation doesn’t stay still over ten years. But the point is that rates in Japan aren’t unambiguously lower than ours in real terms, given their persistently low inflation rate.

    1. right. i was writing about nominal yields.

      and with lower rates being deflationary, no doubt if we keep going the way we are going we’ll have japan like rates, both real and nominal. depending on how we define cpi, of course, which also differs.

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