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How much and how did QE effect rates and how will unwinding look?

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I think we will never have a solid answer for how much QE impacted rates. I heard on Marketplace on NPR a claim that there was a Fed report showing QE had a 1% impact on rates. The paper I find they may be referring to is, to be honest, dense. But the net result, as I understand it, is they are arguing that it is not the level of the Fed’s holdings it is the composition of the portfolio, i.e. the individual securities the Fed is purchasing (or not) which impacts price.

On the level: “Against that backdrop, therefore, the overall effect is modest; on a historical basis, actions to build up SOMA did not have large effects on market pricing.”

On the composition: “As reported in table 10, similar to the market neutrality results, we see significant effects of individual securities holdings on measures of market liquidity. In particular, our coefficients suggest that pre-crisis, holdings consistent with a more liquid portfolio were associated with a higher bid-asked spread”

Now this all may be econometric garbage but it pretty much exactly lines up with what you have been saying for many years. To give my interpretation of the paper: “The level of Fed SOMO holdings doesn’t have much impact because the private sector is just exchanging one very liquid asset for an ever more liquid asset. The particular choice of securities the Fed purchases does impact how market participants view the desirability of certain securities which results in these being mis-priced”

The bottom line is there are arguments and data which suggest QE had some effect but perhaps only because of composition. Taken together this would indicate, as I think his highly probable, unwinding QE by letting securities mature (i.e. not making trading decisions), will have very little impact on the market.

I would guess this will be your thinking as well. Correct?

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Posted by John Daschbach
Posted on 09/21/2017 5:01 PM
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I don’t think it’s very clear at all. One thing we know is that QE was designed to boost growth and inflation and it did not do that much if at all. So I think it’s hard to argue that QE had a huge impact.

That said, I do think QE1 was quite important. This is just common sense. The banks had assets that we trading at discounts and the Fed’s policies swapped those assets with assets that we super high quality. This definitively helped their capital positions and shored up the financial system. But the later iterations of QE probably didn’t do much. This also makes sense since QE is really just swapping savings accounts (tbonds) for checking accounts (deposits).

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Cullen Roche Posted by Cullen Roche
Answered on 09/25/2017 7:05 PM
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    I wasn’t arguing that QE had much impact since I have consistently argued that based on the data which shows that net TSY10 and MTG30 went up during QE on periods and down in QE off periods. I was pointing out the Fed is writing white papers to support their position that QE had an impact but in fact not through the overall level of balance sheet which most people on the anti-Fed side argue about.

    I would agree that QE1 did help banks improve their balance sheets enough to make them able to lend to high quality borrowers. But I don’t see in the data, as a scientist looks at it, evidence that QE lowered yields (since the data in fact show the opposite).

    But there remains an industry of anti-QE people out there, as evidenced by the New Yorker article below, which believe in a conspiracy theory type way that the Fed is able to manipulate the markets almost at will. My view is that QE had little measurable impact on rates, it certainly didn’t bring about the hyperinflation people like John Taylor and others predicted, and especially because the GOP will get some type of tax rate cut for the very top which will increase demand for safe bonds, that TSY rates are not going to increase substantially. As I’ve also argued, the long term limit is that a nearly perfectly safe asset like a TSY10 has to have an equilibrium real interest rate less than 0 or you have constructed a perpetual motion machine which we know from Thermodynamics is impossible. The long term history of US and UK government bonds shows a real return less than 0.

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    Posted by John Daschbach
    Answered on 09/29/2017 4:22 PM
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