QE Isn’t the Economic Boost Many Believe

Last year, central banks around the world employed quantitative easing (QE) policies to stimulate economic activity following widespread COVID-related economic lockdowns. While these measures improved investor sentiment, QE may not be as helpful to the global economy as central banks intended.

The theory goes that QE encourages lending by lowering long-term interest rates, thereby reducing borrowing costs for businesses and consumers. But Fisher Investments UK believes QE may actually be more of an economic and investment headwind than tailwind. In this article, we’ll discuss what QE is, how it actually works in practice and what it means for investors today.

What is QE and why do central bankers use it?

Quantitative easing refers to central banks’ long-term bond-buying programs. When a central bank buys huge quantities of government bonds, it drives the prices of those bonds up and yields down since bond prices and yields have an inverse relationship. Considering banks often use these bond yields as a reference rate for new loans, QE supporters argue lower interest rates will spur demand for cheaper loans. Another supposed benefit is that commercial banks will be flooded with excess funds, enabling them to lend more and stimulate economic activity. While this theory may seem plausible, history tells us QE is hardly economic rocket fuel.

QE is good in theory—not in practice

QE neglects a key aspect of the lending formula—the yield curve spread. The yield curve spread is the difference between long-term interest rates and short-term interest rates, and it roughly represents banks’ profits. Banks lend money at long-term rates and borrow money at short-term rates for customer deposits. The wider the spread, the more profitable it is for banks to make new loans—and the more likely they are to lend.

When QE lowers long rates, it compresses the yield curve spread, reducing banks’ potential profits and incentive to make new loans. While QE can inject banks with additional cash, banks won’t necessarily use that money to issue new loans. Instead, banks may keep that money as excess reserves. So, central banks’ theory hasn’t historically worked as planned, and Fisher Investments UK believes QE slows economic growth rather than stimulates it. In our view, stocks and economies advance despite QE rather than because of it.

What QE means for investors today

Since many central banks restarted QE in 2020, talk today has largely turned to what happens when QE programs slow purchases (aka taper) and, eventually, end.

In spring 2021, the Bank of Canada and the Bank of England both announced plans to start tapering their QE programs, leading many investors to speculate when other central banks will follow suit and what it means for their economies. However, we caution against paying too much heed to these forecasts. Central bankers are human and can change their minds without warning, which is why we believe trying to forecast central bank actions is feckless.

Further, given QE doesn’t provide the economic boost many think it will, we don’t think tapering is inherently bad. Instead, it may even be a mild positive, as it removes some downward pressure on long-term interest rates. A look back at the last bull market, when tapering was a primary investor concern, suggests winding down QE programs shouldn’t derail the current bull market cycle.

For example, the US Federal Reserve began publicly discussing tapering on May 22, 2013 and eventually announced plans to begin tapering and end its QE program on October 31, 2014. Over that timeframe, the MSCI USA Index rose 24.5% (in US dollars).[i] Although US 10-year Treasury yields shot from 2.0% to 3.0% from May to September 2013, by October the next year yields stood at 2.3%.[ii] It wasn’t quite the big negative that doomsayers predicted. In the following years, the US hiked short-term interest rates multiple times and began unwinding QE in 2017—yet the bull market continued. Don’t be so sure tapering is an inherent negative for equities—it may well be the opposite.

As the year goes on, stay calm and expect news headlines to continue featuring QE developments. While many think QE boosts economic activity and that its end might be bad for the economy and markets, Fisher Investments UK believes markets rise despite QE, not because of it. False fears often prove to be market tailwinds and tend to reward patient investors.

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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

[i] Source: FactSet, as of 5/13/2021. MSCI USA Index total return, in US dollars, net, 5/22/2013 – 10/31/2014.

[ii] Source: FactSet, as of 5/11/2021. 10-year Treasury yield, 5/22/2013 – 10/31/2014.