Brian B. Sullivan, CFA, President and Chief Investment Officer, Regions Investment Management
December 5, 2013
A column to help investors gain perspective on today's market noise
The End of QE
In June, Ben Bernanke said that the Federal Reserves’ massive bond buying program was nearing an end. Investors reacted poorly upon that news. Stocks dropped about 7% and bond yields rose more than half percent.
To better understand why that happened, I want to break down what this bond buying program is. It is called “Quantitative Easing” or “QE.” The planned end of QE is known as “tapering.” The timing of the taper is unknown, even to the Fed members themselves; however, just about everybody thinks it will start soon. We speculate that once started, the taper will take about nine months to complete.
QE amounts to monthly purchases of Treasury and mortgage bonds totaling $85 billion. The money used to buy these bonds has flowed into bank deposits and made the banking system very liquid. Liquidity was one of the original goals of QE and has clearly been achieved. The Fed also intended that these new funds would stimulate lending and borrowing. This goal has not been achieved in a satisfactory manner.
If the Fed’s cash is merely sitting in the banking system without being loaned out, it is not stimulative to the economy. Banks have about $2 trillion in “excess” reserves. These are funds that banks could loan out without having to raise capital by selling bonds or stock. The benefit of growing this $2 trillion of “excess” reserves is questionable. Tapering will show the growth rate of these funds.
Will tapering cause economic or banking distress? Clearly not. Yet, investors are nervous that tapering will create an imbalance among buyers and sellers. Removal of an $85 billion per month buyer will affect bond yields and it may affect demand for stocks. QE is unprecedented in our past and its effects and after-effects are not well understood. However, across the pond, we have one current example: Starting near the end of 2011, the European Central Bank began to taper its bond buying program. Shortly thereafter, it began selling its bond holdings. That is QE in reverse. This process began while Europe was in a recession and the banking system was shaky. The economy has since recovered, the stock markets are up, yields are down and government deficits are less.
Tapering of the Fed’s purchases and the eventual sale of the current holdings does not seem to be such a big risk now, does it?
© Regions Bank, Member FDIC. The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM). RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation. The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person. Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, and may go down in value. Investment advisory services are offered through RIM, a Registered Investment Adviser. RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.