Markets Don’t Mind QE Tapers

After significant will-they-or-won’t-they speculation among onlookers, the Bank of Canada (BoC) slowed its long-term bond purchases—or, tapered its quantitative easing (QE) program—on April 21. Nothing untoward happened. Its economy and markets haven’t tanked. Yields haven’t soared. The UK’s Bank of England (BoE) followed suit last Thursday. While it has only been a couple of days since, there has been no identifiable market impact. With two major global central banks dialing back QE, more chatter over the timing of an eventual Fed taper—and its effects—is probably coming soon. Tune it down. Central bank decisions can’t be forecast, and available evidence shows tapering isn’t negative.

Off the bat, attempts to predict Fed and other central bank moves are pointless. In the US, it isn’t 100% clear who will make those decisions, considering the rotating cast of Fed heads and committee voters. For example, speculation is rife over whether President Joe Biden will reappoint current Fed head Jerome Powell when his term expires next February—if he still wants the job. But even if the Fed folks don’t change, central bankers—being human—can change their minds on their own accord without any preset rationale. The Fed and BoE defied their own forward guidance multiple times over the past decade. Former Fed head Ben Bernanke made a big show of providing “numerical thresholds” for conducting monetary policy in 2012, saying a 6.5% unemployment rate would trigger hike rates, only for his successor, now Treasury Secretary Janet Yellen, to scrap it when she took the reins in 2014. Then that year, when Yellen (seemingly) clarified the Fed would hike rates six months after QE’s end, that didn’t happen either. The “dot plot” of Fed forecasts, published quarterly, is no more reliable a guide.

More importantly for investors, divining central banks’ will is unnecessary—there is no evidence tapering QE is a game changer for markets. In the few weeks since the BoC reduced weekly bond buying to C$3 billion from C$4 billion, and the few days the BoE dropped its weekly purchases to £3.4 billion from £4.4 billion, markets have taken tapering in stride. Both the MSCI Canada and UK Indexes have made new highs since their central banks’ announcements. Meanwhile, 10-year Canada and UK government yields are practically unchanged. While we wouldn’t read too much into short-term market moves, tapering so far has had no discernable effects.

This shouldn’t shock anyone. While lots of people talk as if tapering was some kind of watershed moment in the last bull market, the evidence for this is lacking. From when Bernanke first introduced “taper” into investors’ lexicon on May 22, 2013, through its official announcement to actual tapering and QE’s eventual end on Halloween 2014, the S&P 500 rallied 24.1%.^[i] Although 10-year Treasury yields shot from 2.0% to 3.0% from May to September 2013, by October the next year they stood at 2.3%.^[ii] Then, to follow the Fed’s decade-long monetary policy adventure to its conclusion, 2015’s rate hike didn’t stop the bull. Nor did further rate hikes and QE’s ever-so-gradual unwind starting 2017.

The imperceptible impact of the Fed removing its extraordinary “support” measures isn’t surprising. QE has never worked as advertised. Because bond yields move inversely to prices, the Fed’s QE purchases worked to lower long-term interest rates, ostensibly to spur loan growth and, in turn, economic activity. But at best QE was ineffective doing so and at worst counterproductive. Banks borrow at short-term rates (e.g., what they pay depositors) to fund longer-term loans. The difference between the two is a proxy for banks’ loan profitability. When the Fed lowers long-term rates—while pinning short-term rates near zero—it shrinks that gap, which we don’t think increases banks’ propensity to lend. So while QE—then and now—has caused money supply to surge, that hasn’t translated into aggressive lending. Banks’ oceans of excess reserves suggest they have more cash than they know what to do with. Money that doesn’t circulate doesn’t do much good (or cause much inflation, for that matter).

There is an underappreciated consequence we see from this though, which is worth keeping in mind. If central bank tapering becomes widespread globally, yield curves could steepen around the world, quickening loan growth. The overheating some now fear may become likelier. That said, it wouldn’t be overnight and it is premature to speculate about, in our view, with global yield curves remaining historically flat. Rather, this is just a reminder to always look where others don’t and question popular narratives nearly everyone thinks are true.