Question received from CG about the impact of QE and Fed taper:
I’m not arguing against the data presented on the graph, but if true that most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed, why do the markets get spooked every time there are whispers that the Fed is going to reduce QE?
The comment CG is referring to:
Currently, there is evidence of expansive monetary policy from the Fed, but the overall impact on the financial markets is muted. Most of the QE bond purchases are being parked by banks in interest-bearing, excess reserve deposits at the Fed. The chart below compares Fed balance sheet expansion (QE) to the increase in excess reserve deposits at the Fed.
A classic placebo effect, the Fed is well aware that the major benefit of their quantitative easing program is psychological: there is little monetary impact on the markets.
The markets have no real reason to fear a QE taper. I think this is more psychological than physical. The current mind-set is:
If the Fed begins to taper, that marks the end of the bull market in bonds. Rising bond yields and higher long-term interest rates may slow industry investment and recovery of the housing market and this would be bad for the economy.
In other words, they still have a bearish outlook. At some point they will shift to the counter-argument:
QE taper and rising interest rates indicate Fed faith in the recovery and are a bullish sign for stocks. It also means the economy is reverting to a sustainable path.
The bottom-line is that markets are driven as much by emotion as by logic.