Help me understand QE2

Sorry for the long post, I have a lot of questions. Even if you only answer one question or clarify one point, it'd still help me tremendously.

This is basically what I know (skip this paragraph if you want to get to my actual questions): The whole idea of quantitative easing is to buy treasuries from the banks, thus giving the banks more money which allows them to give out more loans because of fractional reserve banking. The increased supply of loans lowers the cost of borrowing, aka the interest rate. This leads to more investment and spending, which increases GDP. But the increased supply of money causes inflation.

  1. How come bond yields have risen since QE2 was initiated then (Nov 3, 2010)? I thought they were supposed to go down?

  2. Why do critics of QE2 complain that it decreases the value of the dollar? Isn't that good for us since it increases exports and lowers imports, thus reducing our trade deficit?

  3. Why is monetizing the debt so frowned upon? Sure it leads to inflation, but don't the benefits of the resulting lower interest rates outweigh the negatives of inflation in our current economic climate?

  4. Did QE2 "work"? Unemployment dropped 1% and the stock market has gained a lot, but on the other hand there is higher inflation (although we avoided deflation) and commodities have surged. Whether the pros outweigh the cons, or how much of this is due to QE2, I don't know.

Right now if you put a gun to my head and asked me whether QE2 was the right thing to do, I would (unconfidently) say yes because at the time there was serious threat of deflation which would have been very bad considering the high unemployment rate and the negative effects of deflation on investment. At that point in time we needed the surge in investment.

I've basically been researching from scratch all of this within the past 3 days. I've taken macroeconomics so I know the basics (what the fed does, what an open market operation is), but I have never really taken the time to understand the current economy until now. Any insights, no matter how small, are greatly appreciated.

 

why have interest rates risen? the goal of QE2 was to get people away from ultra safe treasuries and into riskier options such as stocks. when this happens, and people sell treasuries, the price of treasuries decreases, causing the yield to rise. although theoretically QE2 was supposed to lower the interest rate by buying a shitload of treasuries, the flight to risk has caused the yield on treasuries to increase. critics ABROAD complain about the devaluation of the dollar. of course it is good for the US to increase exports and devalue the dollar, and most foreign countries are extremely against this(obviously). did QE2 work? maybe, maybe not. unemployment has dropped, but an enormous amount of that can be attributed to a decrease in the labor force, not people actually getting jobs.

 
  1. another way to think about it, in addition to risk on/risk off, is that the markets are anticipating higher future inflation because of QE2, so they therefore want a higher nominal yield on their bonds
  2. I think the critics are generally complaining not about the dollar exchange rate, but about possible future inflation, which debases US consumer purchasing power, etc 3&4. QE2 has worked in the sense that asset markets have reacted. Commodities have rallied strongly, bringing on non-core inflation, helping to stave off the threat of deflation. Also, the stock market has rallied strongly (Bernanke has explicitly said that this is one of the goals of the Fed). The dollar, at least for a while, dropped on the announcement I think. But in the sense that interest rates have risen, it is a failure. Also, in the sense that the money pumped into the system has not resulted in new loans, it is also a failure. As part of QE, banks get excess reserves, which means that they hypothetically could use these to go out and make more loans if they wanted to. (or alternatively, i've heard that they can just be withdrawn and used like cash by the primary dealers, but i'm not sure on this point) But the excess reserves are still largely sitting around collecting 0.25% interest and not turning into loans- $1.3 trillion worth.
 
junior2012:
But the excess reserves are still largely sitting around collecting 0.25% interest and not turning into loans- $1.3 trillion worth.

This is probably a dumb question, but how do you know this?

Thanks for the input btw, I have a clearer idea now.

 

Banks have sold their treasuries and then bought the treasuries back again at small spread, going full circle. That's why there hasn't been any inflation except commodity prices (due to devalued dollar). Banks buy from the Fed for less than they sold it too so they essentially got free money. They are not releasing the funds, but if they do look for inflation to sky rocket (multiplier effect). Free money help the banks stay liquid and avoid the huge write offs that are on their heels from the real estate loans

Do what you want not what you can!
 
TheKing:
Cartwright:
Good stuff, but, while there is plenty to criticize about QE2 a lot of that is incorrect or misleading.

Such as? Would like to hear specifics as I'm not really sure how you can legitimately defend QE2 (or QE in general.)

The core CPI is used to measure inflation not the CPI but of course the video is too bias to state that. Bond buying is the most common method of injecting money into the economy, but the video is too bias to state that. Bernanke does have policy experience, but the video is too biased to state that. The money supply has been expanded and contracted in the past but the video is too bias to state that. It's a funny video but it's sad that is exactly what the average dumb American believes

 
Best Response
Nikhiln25:
TheKing:
Cartwright:
Good stuff, but, while there is plenty to criticize about QE2 a lot of that is incorrect or misleading.

Such as? Would like to hear specifics as I'm not really sure how you can legitimately defend QE2 (or QE in general.)

The core CPI is used to measure inflation not the CPI but of course the video is too bias to state that. Bond buying is the most common method of injecting money into the economy, but the video is too bias to state that. Bernanke does have policy experience, but the video is too biased to state that. The money supply has been expanded and contracted in the past but the video is too bias to state that. It's a funny video but it's sad that is exactly what the average dumb American believes

Core CPI is a bogus number to begin with. Newsflash, people buy food and energy, and for many people those items are the bulk of their expenditures. Arbitrarily excluding these costs because they are so volatile, and then basing policy decisions off of the result doesn't make a whole lot of sense in my opinion. You're right that bond buying the most common method of injecting money into the economy, but thats not the point. Rates have been low for a while now, it wasn't a lack of loanable funds keeping people from borrowing, its lack of demand for borrowed funds. This country is deleveraging, as it should, but that doesn't help grow the country since everything here is based on borrowed money.

 

So is QE2 a good thing or not? DJI would probably come down a bit if it doesn't happen. The last rally was based on QE2. How would it impact SL?

"The higher up the mountain, the more treacherous the path" -Frank Underwood
 

A lot of the money flowing into the so called Asian Tigers is coming from China, and their tightening has led to a flow of capital seeking higher returns outside. I don't know what would happen given QE2, but at least this time round the governments are better prepared with both the Asian Financial Crisis and Credit Crisis fresh in their memories, and are already acting to cool down the economies.

 

I could’ve been clearer on this sorry, one effect of QE2, which I think is likely to happen, is that even more short term outside capital would flood in hoping for higher returns (carry trades, etc) further raising the current all-time valuations of their markets.

Sounds good at first, but high inflation, currency, and commodity prices would be a death knell to actual exporting nations (which most of them are), especially those whose populations are in the lower middle income levels (SL, Thai, Indo, etc).

When the bulls start seeing uncertainty and pull out, the bubble could pop.

squirtlez:
short damn treasuries !!!!!!!!!!!!

This could actually work here squirtz, but then again they'd most likely cut rates, then your fucked.

People like Coldplay and voted for the Nazis, you can't trust people Jeremy
 

On the emerging markets

As more money gets pumped into our US economy, it drives down the cost of borrowing, lending, and decreases the returns from "safe" investments i.e US treasuries. The 10yr is yielding 2.5%ish. This is paltry as compared to Australia,Indonesia, Brazil, Korea etc etc. With the increase in money flows, this will turn away capital inflows to the US, an divert them to other countries. This "hot money" therefore inflates asset values in these emerging economies. Thus, they have to raise benchmark interest rates to combat inflation(Australia earlier this week). This increase in the rate starts a vicious cycle of more capital inflows due to even higher yields. This in turn causes more inflation, and increases the value of the local currency relative to the US dollar. This in turn crumpled exports for these emerging economies, which rely on their undervalued currencies to support their exports, which is the basis of their economy. The only country that wins is the US, because we decrease our current account deficit by exporting more, our companies good become cheaper oversees, etc etc. That is why their is a "currency war" and restrictions on capital inflows

 

The equity markets and the dollar have no direct correlation.

The basis for that argument just depends on what your school of thought is on asset prices..EMH, random walk, brownian motion, irrational exuberance, unfounded skepticism, luck, momentum or irrational investors

Who really knows what's supporting our equity markets. We have record outflows of $ from mutual funds, low trading volume, and a load of other factors thy truly defy this market were in. But of course, the market is forward looking. Anything you hear will just be an opinion, as is what in saying. Everything is subject to scrutiny, as I welcome any contrary dispositions.

Now the bond market is a whole different animal that is being distorted like crazy.

 

I would say it's not exactly the view of a weak dollar that is rallying the market. Investor's are buying into the idea of QE2 with more stimulus from the Fed which is propping the equity market up. As we see that today, the market is flat or down a little as of mid-day even though we got strong NFP numbers. That is because investors are now worried that the Fed might reconsider QE, and there were talks of QE3 couple of days ago which has all disappeared today, thus the lackluster market today.

 

dunno about qe1 but qe2 was short term debts up to 10 year they didn't buy as much of the 20 year that is why a short tlt trade really paid off look at yield curve if you owned 20/30 yr you really got your ass handed to you i think they are going to have to buy more 10 years though bc it is linked to mortage rates no one buying houses + higher % rates = slower housing recover

 
blastoise:
dunno about qe1 but qe2 was short term debts up to 10 year they didn't buy as much of the 20 year that is why a short tlt trade really paid off look at yield curve if you owned 20/30 yr you really got your ass handed to you i think they are going to have to buy more 10 years though bc it is linked to mortage rates no one buying houses + higher % rates = slower housing recover

Exactly what I was looking for. Thanks.

 

In a statement after the F.O.M.C. announcement, the New York Federal Reserve, which handles the bond purchases, said the purchases will include bonds ranging for less than 2 year to 30 years, with “an average duration of between 5 and 6 years.”

i heard some where it was mostly going to be quick maturing bonds but they will BUY the 30/20 yr but not as much so the correct answer is all years but NOT AS MUCH long term debt

cnbc said ------ With the Fed buying almost everything in the middle of the yield curve, the Street is full of talk about a steepening yield curve, which would benefit banks. ***disclamer im not very good at fixed income ****

see mostly short imo 5/10 is short compared to 20/30 but obvsiously it isn't the 6mo /2/5 yr so maybe shouldn't say short term i guess author is right with middle term the reason is bc they want investors to go some where else maybe buy corporate debt to encourage businesses to spend ...for some reason they do not want to spend record cash etc etc. 30 yr is a god damn 4.2% 10 year 2.8% ~200 bases points more for long term , every 1 knows there will be inflation only a matter of time look at yield curve

it looks like the formula y = 3x + .2 ...

steep as ****

that is why i think fed going to buy mostly 10 yr

 

You might find the following paper helpful: http://www.ny.frb.org/research/staff_reports/sr441.pdf

It's a paper that looks at the effects of QE1. At the end of the paper they have a bunch of charts. They break down treasury purchases by maturity and MBS purchases by coupon.

Also, blastoise, I don't think they're planning on buying 30 year.

They chose to focus around the 4-10 year maturities because they were hoping to influence private lending with maturities around 4-10 years (think cars, students loans, etc...).

If you don't understand the basic arguments for QE, your paper (I'm assuming it's a paper) will be very hard to write. Read the first 10 or so pages of that paper I linked to and you should have a much better idea of what the Fed is trying to achieve with further LSAPs.

 

my understanding is, you can think of excess reserves as the equivalent of treasuries, since banks get paid an interest rate of 0.25% on excess reserves they store with the fed. so having money parked in excess reserves is like having money parked in very short term treasuries, because the low interest rate is on par with short term treasuries. since QE is exchanging longer-term treasuries for excess reserves, you are basically swapping out the longer term treasury for a much shorter term treasury, thus shortening the maturity of the outstanding debt.

this link also might help: http://pragcap.com/mechanics-qe-transaction

 

The fed buying bonds pushes real rates (note: NOT nominal rates) down which makes financing business projects cheaper which reduces unemployment.

Your line of reasoning isn't "right" because in theory wages should go up with inflation as well so purchasing power remains the same. This idea can (and probably should) be argued.

Also the recent decrease in unemployment doesn't make your logic correct or incorrect. It's just one result; economics isn't physics or chemistry and you need a bit more than one result to validate or invalidate a theory.

 
jsmort11:
The fed buying bonds pushes real rates (note: NOT nominal rates) down which makes financing business projects cheaper which reduces unemployment.

This. When loans are cheaper in real terms businesses will seek funds to drive growth (growth=more employees).

 

Unemployment isnt the measure of people out of work, its the measure of people out of work who are actively seeking work. The government is cheap and they just use the number of people who get unemployment checks divided by the assumed size of the labor force. So with the larger numbers of people loosing benefits the number has to go down even if employment is not actually up in any real sesne.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

Provident sit libero id dicta consequatur ducimus praesentium. Voluptas assumenda dolorum id perspiciatis nisi. Rerum debitis veniam et ut. Praesentium velit expedita perspiciatis quia dolore dolores.

Ut modi eligendi hic fugiat vel modi in adipisci. Delectus beatae tempore omnis. Esse magni maiores ex eos nisi aut repudiandae. Pariatur nisi voluptatem maxime voluptatum.

 

Et quo sed sit praesentium deleniti fuga similique possimus. Magni aperiam quod ipsam sed suscipit.

Voluptatum vel porro voluptatem ducimus esse ea. Omnis consequatur numquam vitae.

Perferendis est consectetur quos ut qui quaerat aut. Cupiditate et dolor consectetur tempora hic qui consequatur. Quo molestias et cupiditate consequatur debitis. Non dolor voluptatibus corrupti amet quo eos. At ullam rerum est error sed in. Minus aliquid sint voluptatum minus sint. Optio voluptatem et placeat praesentium.

 

Ipsa fugit neque pariatur quia doloribus minus. Et temporibus ut expedita non. Omnis saepe sit omnis rerum sint eveniet vel. Nam et ut deleniti sit.

Provident sed blanditiis neque corrupti. Qui est cum nostrum harum similique non fugit. Enim eaque deserunt quia consequuntur animi odit voluptate iusto. Ducimus explicabo vitae exercitationem non est. Quam autem facere perspiciatis harum dolores doloremque.

Deserunt pariatur quis autem voluptas. Reiciendis natus reiciendis sit aut inventore non sapiente quia. Eum nam sapiente perferendis itaque alias explicabo laudantium numquam. Quia expedita modi tenetur voluptatibus itaque corporis. Qui dolor facere minima neque nihil eveniet. Ut qui eum quisquam vitae ut perferendis. Reiciendis dolorem aliquid ipsum suscipit eius porro nihil.

Ea rerum rerum commodi ut. Eaque molestiae harum perspiciatis nulla ut. Quasi minus quidem voluptatem natus cumque consectetur. Qui illum delectus quia ab neque et. Dolorum at neque ea occaecati veniam iure iure.

"Have you ever tried to use a chain with 3 weak links? I have, and now I no longer own an arctic wolf." -Dwight Schrute

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (202) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
kanon's picture
kanon
98.9
6
DrApeman's picture
DrApeman
98.9
7
dosk17's picture
dosk17
98.9
8
CompBanker's picture
CompBanker
98.9
9
GameTheory's picture
GameTheory
98.9
10
numi's picture
numi
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”