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In October, when the Federal Reserve announced that it would begin buying Treasury bills to increase the size of its balance sheet, the burning question was: Is the Fed restarting quantitative easing?
The Fed insists that the current balance sheet expansion is not QE, the bond-buying operations between 2008 and 2014 that were designed to lower long-term rates and provide economic stimulus.
“I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis,” Fed Chairman Jerome Powell said in an Oct. 8 speech to the National Association of Business Economists in Denver.
This time around, the central bank is buying short-term Treasuries to the tune of $60 billion a month, along with temporary cash injections via overnight and term repurchase agreements, to alleviate the reserves shortage in the banking system.
That shortage manifested itself with a spike in the cost of overnight borrowing, or repo rates, in September when the corporate tax payment coincided with the settlement of Treasury auctions, inflating cash demands.
Read: Fed’s undersubscribed repo offering suggests waning pressure on funding markets
‘Organic’ operations
Powell refers to this internal plumbing exercise — increasing the size of the Fed’s balance sheet in order to satisfy the banking system’s demand for reserves — as “organic.” (As opposed to inorganic previously?)
What exactly is different now compared with the Fed’s earlier rounds of QE? Today’s not-QE (what else does one call it?) is not intended to goose aggregate demand. The economy, the Fed constantly reminds us, is “in a good place,” its policy stance “appropriate” to the current circumstances.
What’s more, the three earlier rounds of large-scale asset purchases were focused on lowering long-term interest rates to stimulate demand for housing and investment, whose borrowing costs are generally tied to the long-term risk-free rate, and to prod investors to buy riskier assets, such as stocks and corporate bonds, in turn lifting their prices.
Finally, QE came packaged with forward guidance, with the Fed promising to hold short-term rates “lower for longer” to prevent long-term rates from pricing in rate hikes prematurely. (Powell has said it would take a “significant” and “persistent” increase in inflation for the Fed to raise rates, but the backdrop today is much different than it was following the financial crisis.)
So based on the Fed’s explanation of the means and ends of its earlier initiatives, its current actions do not qualify as QE.
Taking the ‘Q’ out of ‘QE’
Even those earlier actions weren’t true to their name. I like to say that the Fed took the Q out of QE when it started paying banks interest on reserves, or the deposits banks hold either voluntarily or because they are required to, curtailing a natural expansion of money and credit.
“Monetary policy is now divorced from money,” is how David Beckworth, a senior research fellow at George Mason University’s Mercatus Center, put it.
In effect, the Fed was paying banks not to lend at a time when the U.S. could have used a more expansionary monetary policy — with the Fed’s initial cash injections promoting a more rapid growth in the money supply — to dig out from the Great Recession.
At the same time, banks were forced to hold more reserves to satisfy the more stringent liquidity coverage ratios imposed after the financial crisis.
Relation to earnings
So is not-QE the reason the stock market continues to register one new high after another in the face of tepid earnings forecasts?
I doubt it. The demand for any asset that provides a positive return over and above that available on risk-free Treasuries — which, by the way, have performed well this year — is the result of the ultra-low interest-rate environment in the developed world.
After a series of four, 25-basis-point rate increases in 2018, the Fed reversed itself, lowering rates by 75 basis points between July and October. It has indicated that it is in no rush to raise rates anytime soon.
Stocks seem to have become a kind of safe haven. The stock market, represented by the S&P 500 SPX, +0.31%, generally goes up over time, which is no guarantee that it will be at lofty heights if, and when, you need to sell.
The idiosyncracies of the Fed’s balance sheet seem more arcane and less relevant to the average investor than the well-publicized benchmark rate. So if there’s a motivator for the stock market rally, the persistently low level of interest rates, not the expanding balance sheet, would seem to be the more likely culprit.
Caroline Baum is a MarketWatch columnist.
