Global ratings agency, Fitch estimates that the value of Quantitative Easing (QE) implemented this year could reach $9 trillion! To put that in context, that is equal to more than half the cumulative total global QE that occurred between 2009 and 2018! The Federal Reserve in the US has alone pumped $4 trillion into the market over the past 11 weeks. This is absolutely unprecedented.
Should investors be worried about the long-term impact of all this money printing (QE)? What are the risks that we need to be aware of?
The role of central banks
Central banks around the world are in charge of monetary policy. The aim of monetary policy is to ensure a healthy economy and an inflation rate that is within the stated goal.
When the economic activity increases and the economy approaches fully capacity, inflation can begin to increase. In this situation, the central bank would normally increase interest rates (to reduce corporate profits and consumer spending) to cool economic demand. If the economy slows down, the central bank can cut rates to stimulate demand again.
Interest rates is a central bank’s primary tool.
What is QE?
When interest rates stop being an effective monetary policy tool, central banks start to consider more unconventional mechanisms such as QE. QE is the process of a central bank buying assets such as bonds. They do that by issuing new currency i.e. increasing money supply (often referred to as money printing). The aim is to stimulate the economy as a whole through injecting more money into the economy.
The US Federal Reserve started buying Mortgage Backed Securities (MBS) in 2009 to help the US recover from the impact of the GFC. The idea is that lenders could sell MBS to the Fed Reserve to raise funds. In doing so, banks would then have more funds to lend to property investors and homeowners. In turn this should stimulate demand for housing and aid in the property market’s recovery. To a large degree, it worked.
QE is not limited to MBS, however. Central banks can buy other assets including corporate bonds and even equities, which Bank of Japan has done. Central banks can target certain sectors of the economy if they so choose.
What has happened this year?
Most central banks around the globe have participated in QE, including Australia’s RBA, the US Fed Reserve, Bank of England, European Central Bank and Bank of Japan. For the most part, the QE programs have been much wider than what they were during the GFC. Central banks have been buying corporate bonds (the aim is to increase lending to the SME sector) and Exchange Traded Funds (some of which invest in non-investment-grade corporate bonds, which is seen as aggressive).
As noted in my opening paragraph, Fitch estimates that the total value of global QE in 2020 to be circa $9 trillion (AUD)!
The RBA has been providing money to Australian banks at a
fixed rate of 0.25% for 3 years to promote lending to home owners and businesses. That is why fixed rates have been so attractive lately.
What impact will QE have on our investments?
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