By Jake Willms, Quantitative Analyst
It’s no secret that the Federal Reserve has been utilizing Quantitative Easing (“QE”) over the last decade to assist in market recovery efforts and keep interest rates low. When a central bank uses QE, they are essentially creating credit to purchase government bonds and or securities from banks and institutions. This helps increase the supply of money which in turn, lowers the cost of money. Banks can now lend more on easier turns, and as a result the whole thing drives economic activity for citizens all over.
Skeptics question how much of a direct impact QE can have on bond prices, suggesting it functions more as a signal of upcoming policy to keep rates low rather than the mechanism that actually manages them. When financial analysts from Société Générale set out to answer this question, they found something else that is far more interesting to investors.
As it turns out, QE has had a dramatic effect on equity pricing over the last decade, as shown by the price comparisons of the S&P 500 and the Nasdaq 100 indexes. Without the influence of QE on markets, U.S. stocks were more often the driver of the bond market and its prices, but with QE, this has flipped completely. Equity prices seem to have grown increasingly related to bond yields. I speculate this is because the extra money being injected into the economy from QE purchases is often times ending up in equity, driving the prices up.
This asks the question then, how much should investors care about QE? Not as much as you might think. For one, yes, it can serve as a positive influence on driving equity prices up and helps with driving market activity, but investors shouldn’t worry about its use. In essence, QE is allowing investors to “cash out” of bonds and put the money to work elsewhere, so even if it might seem suspicious and unsustainable, the Federal Reserve remains firm that it can be sorted out at a later date, well after an economic recovery from the ongoing pandemic.