The Fed has concluded its asset-purchasing program thanks to an improving labor market. Here's what QE3 has meant to investors and the economy.
After spending trillions of dollars on bond purchases since the end of the Great Recession — to keep interest rates low to boost spending, lending, and investments — the Federal Reserve ended its stimulus program known as quantitative easing.
The central bank’s decision to stop buying billions of dollars of Treasury and mortgage-related bonds each month comes as the U.S. economy has shown signs of recent improvement.
U.S. gross domestic product grew an impressive 4.6% last quarter. And while growth dropped at the start of this year, thanks to an unusually bad winter, the economy expanded at annual pace of 4.5% and 3.5% in the second half of 2013.
Meanwhile, employers have added an average of 227,000 jobs this year and the unemployment rate rests at a post-recession low of 5.9%. It was at 7.8% in September 2012, when this round of quantitative easing, known as QE3, began.
What this means for interest rates
Even with QE over, the Fed is unlikely to start raising short-term interest rates until next year, at the earliest.
In part due to the strengthening dollar and weakening foreign economies, inflation has failed to pick up despite the Fed’s unprecedented easy monetary policy.
And there remains a decent bit of slack in the labor market. For instance, there are still a large number of Americans who’ve been unemployed for 27 weeks or longer (almost 3 million), and the labor-force participation rate has continued its decade long decline. Even the participation rate of those between 25 to 54 is lower than it was pre-recession.
What this means for investors
For investors, this marks the end of a wild ride that saw equity prices rise, bond yields remain muted, and hand wringing over inflation expectations that never materialized.
Equities enjoyed an impressive run up after then-Fed Chair Ben Bernanke announced the start of a third round of bond buying in September 2012. Of course the last two times the Fed ended quantitative easing, equities faced sell-offs. From the Wall Street Journal:
The S&P 500 rose 35% during QE1 (Dec. 2008 through March 2010), gained 10% during QE2 (Nov. 2010 through June 2011) and has gained about 30% during QE3 (from Sept. 2012 through this month), according to S&P Dow Jones Indices.
Three months after QE1 ended, the S&P 500 fell 12%. And three months after QE2 concluded, the S&P 500 was down 14%.
10-year Treasury yields:
As has been the case for much of the post-recession recovery, U.S. borrowing costs have remained low thanks to a lack of strong consumer demand — and the Fed’s bond buying. Many investors paid dearly for betting incorrectly on Treasuries, including the Bill Gross who recently left his perch at Pimco for Janus.
10-year breakeven inflation rate:
A sign that inflation failed to take hold despite unconventionally accommodative monetary policy is the so-called 10-year breakeven rate, which measures the difference between the yield on 10-year Treasuries and Treasury Inflation Protected Securities, or TIPS. The higher the gap, the higher the market’s expectation for inflation. As you can see, no such expectation really materialized.
Despite concern that the Fed’s policy would lead to run-away inflation, we remain mired in a low-inflation environment.
The falling unemployment rate has been a real a bright spot for the economy. If you look at a broader measure of employment, one which takes into account those who’ve just given up looking for a job and part-time workers who want to work full-time, unemployment is elevated, but declining.
Indeed, many economists now argue that the European Central Bank, faced with an economy that’s teetering on another recession, ought to take a page from the Fed’s playbook and try its own brand of quantitative easing.