I don't have a strong opinion on whether QE is inflationary or disinflationary (history seems to show that it is neither), but I do tend to agree with this article that QE has dictated the direction of the stock market since last December's slump (when the Fed was in QT) and this latest rally (with the Fed back to QE) -
The Federal Reserve's rescue of the overnight lending market appears to be having an unintended side effect: it's juicing the stock market.
The September spike in overnight lending rates revealed that the plumbing of the financial markets was broken. Banks and other financial institutions simply didn't have enough cash. The Fed, acting as a plumber, started pumping in lots of cash to ease the crunch.
In addition to temporary cash injections, the Fed reversed course by promising to purchase bonds — a ton of them. After months of shrinking its balance sheet, the Fed vowed to buy $60 billion worth of Treasury bills per month through the spring of 2020.
As a result, the Fed's balance sheet has swelled by $286 billion since early September, to $4.05 trillion.
As they say, don't fight the Fed! But I do wonder if there is a limit to how big of a balance sheet the Fed can have? Americans are fortunate that the rest of the world that can compete for investment dollars seem to be in even worse shape than the US...
Anecdotally, I also seem to hear from lots of people that they have 'a lot of cash' sitting on the sidelines waiting for a big drop so they can buy in. If ever there were going to be a time when QE would be inflationary, I would think now would be it.
I think markets have learned not only to not fight the fed, but also to trust the fed. Since the introduction of at-scale QE/QT as the US’s main monetary tool circa 2008, market participants have watched inflation be more tightly controlled than the US has managed ever before (Find me a more stable decade, inflation-wise!). Inflation risk has been taken off the table, and it is fair to wonder if the fed’s real inflationary goal is closer to 1.5%, rather than the 2% that is claimed, because they seem to be damn good at keeping it below 2%. Nobody buying billions of dollars worth of bonds at today’s yields thinks 3-4% inflation is at all likely, even though that is the historical norm.
The theory is, if inflation gets a blip over the target, it will we quashed with QT. If it goes below target, it will be boosted with QE. The fed’s QE ability is virtually unlimited, because it could create the currency to buy the entire national debt, if necessary, and then there are private sector assets behind that! The fed’s QT ability is limited by the size of its balance sheet, which is now large enough it would take a truly black swan deflationary tsunami to exhaust it. Taken together, inflation seems to be controlled with engineering certainty - a far cry from the days when the fed only dabbled with the indirect tool of interest rates. Indeed, it may be unnecessary to ever raise interest rates when QT could more effectively control inflation without the damage to businesses and investors that higher rates could cause.
That’s the theory; QE and QT are opposing forces, each operating on a linear scale. But if there is a curve or tipping point beyond which QE and low rates are disinflationary instead of inflationary, then the fed is applying the wrong medicine to prevent disinflation. When one looks at the mistakes that were made leading up to the Great Depression - tariffs, tax hikes, higher rates, tighter lending - one can see that Andrew Mellon and Herbert Hoover genuinely thought these were economic stimuli. Their theory of operation was wrong. If Jerome Powell is wrong about QE always being inflationary/stimulative, and if QE’s effects are a curve instead of a line, well, holy shit. The fed would in fact have 2 disinflationary/inhibitory tools, but would think one of them was inflationary/stimulative.
The thing is, raising rates to hedge that risk or correct course is politically impossible. It would set off a worldwide bond crisis and financial crash because trillions in long term bonds and MBS’s would lose double-digit percentages of their value if interest rates rose by even 2%. So we are locked on course and if QE does become disinflationary it still could not be stopped or even worse things might occur.
All this leads me to an interest in what happened to Japan since 1990. Was their QE non-linear? Are they trapped and unable to raise rates for the reasons described above? I think the implications go way beyond not fighting the fed with one’s stock bets.
