One of the most widely used reason (or excuse) for Quantitative Easing (QE) is that it keeps interest rates low. This is in fact a myth or a bluff and it’s surprising not more people call this bluff. In fact, with the Fed buying mortgage-backed securities or Treasury Bonds, interest rates have to go up. Why is this the case – let’s break down the relationship between QE and Interest rates in simple terms.
– When the Fed embarks on QE, it signals to investors they are providing a backstop for supporting the conomy
– As a result, investors leave Bond markets, and pile into more riskier assets like Stocks
– So money leaves the Bond markets and enters the Stock markets
– If money leaves the bond markets, bond prices fall, and Stock prices increase
– If Bond prices fall, interest rates must go up. This relationship between Bond prices and interest rates cannot be broken.
Its as simple as that. Eric Parnell describes this phenomenon in detail in this post. His post clearly demonstrates how interest rates have gone up on each round of QE, and this makes absolute sense. Interest rates can only go down when Bond prices go up. And Bond prices go up because investors are leaving the stock market and entering the bond market seeking safety. So the question is – why don’t more people, even the so-called experts call the Fed on this bluff ??
