Investors need not fear QE reduction

In his book, Leonard describes how, under the QE program, the Fed will buy bonds from a bank by crediting that bank’s “reserve account,” which, simply put, is a special account that only banks that deal directly with the central bank may have. He then asserts that these banks are free to use these reserves “to buy assets in the market at large”.

That’s just not how it works.

What actually happens is much more complicated and much less exciting. These reserves, which in Australia are called foreign exchange settlement reserves, are a special type of currency that is exchanged only between the central bank and other commercial banks to ensure that the billions in transactions that banks undertake daily are settled every day. These reserves are not the same as the money used in the real world.

Central banks will also buy bonds from other institutions that do not have a special reserve account with them, in which case they settle with normal cash. However, according to the Reserve Bank’s website, these institutions are all credit unions, small banks, or insurance companies. If an institution like that holds bonds in the first place, which are classified as a defensive fixed income asset, it’s pretty much guaranteed that they won’t take the money and put it into cryptocurrencies. .

So what made financial markets rebound so aggressively if it wasn’t central banks printing money? It’s governments, pumping trillions of dollars, pounds, euros, yen and other currencies into economies to sustain them during the COVID-19 crisis.

This money was created out of nothing and is still circulating in their respective economies. In fact, governments create money every day with the click of a button through fiscal policy, with things like social security payments or any other spending program.

Many will argue that it was central bank quantitative easing programs that allowed governments to run deficits – but that’s not true either. Just like before QE, it is the government that spends money to exist that provides the liquidity to banks and others to buy the bonds. Central banks are not required to do anything other than conduct their normal daily interest rate targeting monetary operations.

The fact that central bank QE programs have not stimulated the equity market means that reducing QE, or shrinking their balance sheets, does not necessarily have a negative impact on the equity market.

Chris Bedingfield, portfolio manager at Quay Global Investors, points out that in the first three QE programs, the S&The P 500 rose an average of 2.2% in the month following a QE “event,” whether it was the start, the announcement of the cut, or the conclusion of QE. On average, whether the announcement signaled an easing or tightening of central bank policy, a month later, US stocks were up.

That doesn’t mean stock markets can’t fall – but if they do, it will have more to do with other factors, like valuations, fear, geopolitics or even inflation rather than stocks. the central bank.

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