 | Quantitative Easing and the Bond Market – Can Private Buyers Absorb the Debt? - Part 3 of 3 |
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| Posted Under: GDP • Government • Markets • Fed Reserve • Interest Rates • Bonds |
Since 1975, the amount of marketable debt held outside Federal Reserve (known as privately-held debt) has increased by $9.3 trillion, or $242 billion per year. During the same time frame, GDP has averaged $8.1 trillion per year. In other words, on average, since 1975 the private markets have absorbed Treasury debt equal to 3% of GDP. Over some periods it was more than average, over other periods, less. But there is no clear and consistent relationship between this burden on the private sector and interest rates.
If QE were to completely end tomorrow, the amount of Treasury debt that would have to be absorbed would not be particularly large relative to the size of the US economy. If the Fed suddenly goes "cold turkey" on QE but continues to just rollover the Treasury debt it already owns, all other purchasers of Treasury debt would have to absorb an amount roughly equivalent to the size of the budget deficit, which we think will be about 3% of GDP in the year ahead, no different than the long-term average of how much Treasury debt private markets have absorbed.
More likely, the Fed will taper purchases next year (to about $20B/month) rather than going cold turkey, adding about $250 billion to its holdings. If so, the private markets would have to absorb Treasury debt equal to only about 1.5% of GDP in the next twelve months, low by historical standards. In turn, by the time the Fed completely stops its purchases, the budget deficit should be small enough, at least in the medium term, to keep the amount of debt the private markets need to absorb below the long-term average of 3% of GDP.
We hope the charts and analysis in this series (click here for part one and click here for part two) helps make our case that QE itself is not the driving force behind lower long-term rates. While we believe that interest rates are headed higher in the years ahead, QE itself (or ending it) is not the reason for our forecast. Rates have been held artificially low by the Fed's commitment to low short-term rates, which cannot last forever.
QE itself is just a signaling mechanism and is nowhere near as powerful as the Bears think it is. Ending QE will end a chapter of Fed policy we wish had never come and hope will never return. But, the impact of QE on the economy and financial markets has been much less than many have come to believe.
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