Are We Ready For the End of QE?

Could the economy handle the end of QE?

The bond buying program run by the U.S. Federal Reserve is on track to end this October; essentially, the country will stop printing additional money to help prop up the economy. Known as quantitative easing, or QE, this program increases the supply of money by flooding financial institutions with capital in efforts to promote increased lending and liquidity. QE has been in motion since November 2008, when the Fed introduced it to counter the housing and financial meltdown, and ease the impact on the banking industry.

Now, U.S. economic conditions are looking up – in fact, better than expected this year. The labour market is improving, and unemployment is dropping. U.S. GDP grew at an annual rate of 4.3 per cent in Q2. This unexpected growth further cements the end of QE’s days – but there is concern that stopping support could have consequences to the American economy, and globally.

Here are some of the concerns and predictions surrounded life post-QE.

 Also read: The Trouble with Tapering>

A History of QE in America

To understand the impact of ending QE, it’s important to understand why it was first implemented. After the financial crisis, fears loomed of a credit crunch; the Fed introduced QE by buying nearly $2.1 trillion in treasury bonds and mortgage-backed securities from 2008 to 2010. This made it possible for banks to keep the cost of borrowing low, further encouraging consumers to borrow and spend. This first round of QE was ended in 2010 when the economy experienced an uptick.

However, the U.S. economy was falling behind once more by November of that year and a second round of stimulus, now popularly known as QE2, was introduced.

To understand what the end of Q.E could mean, it’s important to know why it was first implemented. After the financial crisis there was concern lending would become an issue. The Fed introduced QE and bought nearly $2.1 trillion of treasury bonds and mortgage-backed securities from 2008 to early 2010.  It ended this first round when it felt the economy was improving.

But by November 2010 the U.S. economy was falling behind once more and a second round of stimulus, now popularly known as QE2, was announced. In this round, the Fed bought $600 billion in primarily mortgage-backed securities by 2011. QE3 was brought in in 2012 when the Fed again felt the economy needed a boost. This time, stimulus came in the form of the Fed making $85-million bond purchases monthly, driving bond yields, and the fixed cost of borrowing, lower. Then, early this year, U.S. Fed Chair Janet Yellen made headlines stating the program would begin to taper its purchases, with the goal of ending in October 2014.

Inflation is the FED’s main concern

While the economy has improved to the point of ending QE, the American economy is still vulnerable to the effects of inflation. Just as in Canada, the economy can’t withstand a significant price jump or fall. In a statement, the Fed says, “The Committee continues to anticipate, based on its assessment of these factors that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 per cent longer-run goal.”

Low Rates are Not Guaranteed

Ending QE paves the way for a second economic recovery measure: increasing central interest rates from their record lows (currently 0.25 per cent in the U.S.). Yellen is in no rush to raise rates, stating they would not budget for some time in the Fed’s interest rate announcement last week. But some experts say rates will be out of the Fed’s hands once QE ends. As ADVFN CEO Clem Chambers wrote in a recent Forbe’s column, “The only way to ensure low interest rates is for the Fed to buy securities–mainly bonds–and force their price up in what amounts to a market corner.”

Are Markets Prepared?

There are some who say markets will be volatile after QE ends, mainly because the guaranteed liquidity boosting the economy will be gone, which will make it harder to predict market action. Already, the TSX has taken a 15,000 point slide – its biggest losing streak in a year – as analysts try to predict when the U.S. will raise interest rates. As Canadian rates generally follow the Fed’s lead, Canadian businesses, lenders and consumers will feel an American rate rise.

But consider too that such a move won’t come as a shock – the expectation is that rates will rise eventually. Volatility usually occurs when something unexpected happens; for months now, traders around the world have been preparing for the end of QE.

The Canadian Attitude on QE

The Bank of Canada didn’t implement QE after the financial crisis, focusing instead on spending billions on Canada’s Economic Action Plan. But our policy makers are fans of QE – at the G20 finance ministers’ meeting in Cairns, Australia this week, BoC Governor Joe Oliver actually suggested Europe consider a form of QE. He stated, “Europe…is pretty well flat in terms of growth and their inflation rate is close to zero,”and that for the good of the global economy, the ECB should take such measures to avoid a potentially deflationary environment.  He added, “The global recovery is fragile and as a trading nation we are impacted by international demand for our products and services.” Canada will be closely watching the impact the end of QE has next month, as will the bears that say QE4 could be still be in the future.

 

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