Quantitative easing’s effectiveness: Why it matters for investors
Monetary policy: Questioning Bridgewater's thesis (Part 4 of 4)
Asset prices and QE (quantitative easing)
In the previous post in this series, I made the case that asset prices don’t impact the effectiveness of QE. An example of this would be Japan in the last year, where yields on JGBs (Japan’s version of Treasury securities) were near-zero. Despite the extremely high bond prices (which inversely relate to yields), the latest QE program there has had a significant impact on markets.
It’s difficult to argue that high bond prices matter when Japan’s performance provides such a stark counterexample.
Why should investors care about all this?
Monetary policy has been the driver of global equity performance over the last five years. This is because the majority of the world has been hit by insufficient aggregate demand. When this happens, inflation and real growth fall below trend. It also leads to “risk-on, risk-off” behavior in the markets since the dominant driver of equity returns becomes whether or not central banks will stimulate enough aggregate demand for global economies to return to full employment.
The main points that investors should take away from this is to expect continued “risk-on, risk-off” behavior in the markets driven by central banks. The efficacy of these programs will depend on the central banks’ motivations for them. For example, the European Central Bank has been myopically concerned with its sole mandate, price stability, to the detriment of growth in the Eurozone.
QE will have diminishing returns as economies approach full employment, but only because the markets will begin to price in a bigger chance of more contractionary monetary policy.
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