 | Quantitative Easing and the Bond Market – Has QE Held Down Rates? - Part 2 of 3 |
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| Posted Under: Government • Markets • Fed Reserve • Interest Rates • Bonds |
Despite the data presented in part one of this series, many will argue that if the Fed had not done QE, Treasury rates would have risen sharply in recent years. As proof they point to the May announcement of "tapering" by Chairman Bernanke and the immediate 100 basis point rise in long-term interest rates. But this relationship is very difficult, if not impossible, to ascertain by looking at the relationship of QE to interest rates. In fact, if we look at the share of marketable Treasury debt owned by the Fed and compare it to rates, the relationship is the opposite of what many believe.
From late 2007 through early 2009 the share of the debt owned by the Fed plummeted as the federal budget deficit soared and the Fed expanded its balance sheet by buying mortgage securities, not Treasury securities. Yet, Treasury interest rates fell.
From late 2009 through early 2011, the Fed, using QE pushed the share of the debt it owned back up toward the pre-crisis norm. Interest rates were volatile during this period, but trended up slightly.
From early 2011 through the end of 2012, the Fed's share of Treasury debt gradually fell. In theory, interest rates should have risen; instead, they fell.
So far this year, the Fed's share of marketable Treasury debt has risen while interest rates have gone up.
In other words, those who believe QE is holding down rates face a serious lack of data to prove their case. At best QE is a signaling mechanism, not an actual mover of interest rates. The reason the Fed did QE in the first place was because the federal funds rate was at its "zero lower bound." So, when the Fed is committed to QE, it is in effect saying "the funds rate will stay at zero." When it talks about tapering, it is saying "the funds rate may rise at some point in the future."
This is why, during 2013, the Fed increased the share of Treasury debt it held, but because it talked about tapering at the same time, long-term interest rates actually went up. It is also why the Fed is trying so hard to find other ways to signal a longer, and lower, path for future short-term rates by using unemployment rates, inflation or nominal GDP growth as targets.
We believe that the Fed's commitment to holding short-term rates down for a very long period of time into the future is the real reason that long-term rates are so low. So, at least from our point of view, ending QE will not drive interest rates up unless the market thinks ending QE is a signal that short-term rates will go higher.
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