Friday marks not only the start of festivities marking America’s 235th birthday, but also the official end of QE2. But compared to all the hoopla and discussion since its announcement last November, its official end seems to be met with much less fanfare. In fact, the Friday cover of any major newspaper is far more likely to contain stories about former IMF head Dominique Strauss-Kahn, Minnesota’s government shutdownor the possibility Tim Geithner may leave the Treasury. No small topics, but arguably, given the amount of ink spilled on QE2, one would think its official end would get more headlines. (Which speaks in part to news reporting in general—a topic we’ve discussed before.)
But it also likely says something about QE2 as a whole. We’ve said before QE2 was largely unnecessary—the economy was growing and the bull market underway before its implementation, and they haven’t stopped since. Given overall positives have continued (as we’ve documented), QE2 likely hasn’t been the sole propeller keeping the US economy airborne—at least not from a fundamental or economic reading standpoint.
Which is good, considering many feared QE2 would lead to rampant inflation. But that hasn’t turned out to be the case either—not as of yet. Inflation has ticked up slightly over the last several months, but prices have fallen back recently—particularly headline categories like oil and food, which have both softened in recent weeks. And given unemployment remains fairly elevated and capacity utilization is rising but still not maxed out, there are seemingly enough downward pressureson prices right now to keep them from skyrocketing surprisingly. Yes, if money starts moving through the system, that will be a lot of excess money supply likely chasing prices higher. But that still seems a ways off.
Not only did QE2 not ignite rampant inflation, it also didn’t seem to particularly motivate business or private lending—partly because the Fed now pays banks interest on reserves. Banks have seemed mostly willing to park reserves at the Fed and earn the interest (free money!) rather than grapple with current ongoing regulatory uncertainty. To be fair, borrowers haven’t been much interested in levering up, either—also probably because of uncertainty in the mortgage and general lending businesses right now. But either way, banks have yet to deploy much of that liquidity the Fed’s been feeding the market. And until something decreases uncertainty (an extended legislative vacation perhaps) and/or makes lending sufficiently more appealing than earning Fed interest, that probably doesn’t much change.
But it’s entirely possible QE2 did largely help in one area—sentiment. It seems pretty clear the QE2 announcement helped flagging sentiment last year, which contributed to the strong Q4 2010 market rally. Sure, long term, we’d argue fundamentals prevail—but short term, sentiment can be a powerful driver of market returns.
As QE2 sets sail then, the takeaways are: First, as we discussed just Thursday, legislation frequently has unforeseen consequences. In this case so far, QE2’s had the limited (perhaps unintended) consequence of boosting sentiment and not much else—partially because other actions (interest paid on reserves) had a dampening effect. Second, despite someconfused headlineswe’ve seen, the Fed plans on maintaining its balance sheet for now. This means they will continue buying debt—but to replace expiring debt, not expand money supply. No doubt a number of news stories will continue to get this wrong. Third, markets overall this week have been moving fairly strongly up—yes, tied partly to some progress on Greek debtissues, but it’s hard to strip out those impacts from relief at the relative non-event QE2’s end has turned out to be. And we’re fine with an overall shoulder shrug from markets—maybe QE2’s end signals a return to normalcy they’ve been waiting for. Either way, it’s one less thing for markets to sweat in a year so far dominated by scary headlines and dour sentiment.
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