Swedroe: The Surprising Lessons Of QE

November 05, 2014


Ever since the Fed began its policy of QE, there has been an ongoing—and often heated—debate as to whether the Fed was doing the right thing. Many warned that the expansion of the Fed’s balance sheet would lead to a dramatic rise in inflation. After the announcement of QE2, a group of 43 economists published an open letter to then-Fed Chairman Ben Bernanke.

They wrote that the program should be “reconsidered and discontinued.” The planned bond purchases, they said, “risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.”

At the time, many bond forecasters had also made dire predictions about interest rates. They warned investors to buy only short-term bonds because rates were sure to rise and the dollar would fall sharply, perhaps even losing its status as the world’s reserve currency. Such predictions boded ill for the stock market as well.

For example, in March 2011, the 10-year Treasury note was yielding about 3.4 percent. The former “bond king” Bill Gross announced that PIMCO had removed government debt from its flagship fund (PTTRX), arguing that bond levels were unsustainably low given the scale of government debt obligations and the Fed’s quantitative easing program.

Many others were predicting that QE3 would lead to soaring gold prices. How did those forecasts turn out?

Forecasts Versus Reality

At the end of November 2010, the 10-year Treasury yield was about 2.9 percent. As I write this on Oct. 30, 2014, the 10-year yield stands at just 2.3 percent. Strike one.

The inflation rate in 2011 did rise to 3.0 percent. However, in 2012, it fell back to just 1.7 percent. In 2013, it fell further, to 1.5 percent. And the Consumer Price Index rose just 1.7 percent for the first nine months of 2014.

Not only have we not seen rising inflation, but expectations for future inflation are tame. We can observe that in the breakeven rate of inflation between Treasury inflation-protected securities (TIPS) and nominal bonds as well as in economists’ forecasts.

The current breakeven rate between 10-year nominal bonds, which are yielding about 2.3 percent, and 10-year TIPS, which are yielding about 0.4 percent, is just 1.9 percent.

Clearly, the market is not expecting rapid inflation. And the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters has a 10-year inflation forecast of just 2.2 percent. Strike two.

As to the value of the dollar, at the end of November 2010, the Fed showed the trade-weighted value of the dollar at about 100. As of Oct. 22, the Fed showed that its value was just below 106. Strike three.



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