Oops! They QE’d Again

The US Federal Reserve (Fed) has gone back to expanding its balance sheet. Some claim that quantitative easing (QE) is back; the Fed denies it. What we call it isn’t the point, says Sonal Desai, Franklin Templeton Fixed Income CIO—what matters are the implications of this “permanently loose” policy stance for asset prices, investment strategy and market volatility.

The Federal Reserve (Fed) has expanded its balance sheet by about $400 billion since last September. This has reversed more than half of the balance sheet unwinding (about $700 billion), which the Fed had started in October 2017.1 A growing number of analysts and investors have concluded that the Fed is once again engaged in quantitative easing (QE). The Fed denies it.

Since the facts and numbers are not in question, does it matter what we call it? As I argue below, whether we call it QE or not is largely semantics; but its impact and what it tells us about the Fed’s priorities is substance—and it matters from an investment perspective.

A Brief History of Stress

Last September, repo markets2 suffered a bout of stress triggered by a sudden liquidity crunch, which caused repo rates to spike and the Fed’s policy rate (the fed funds rate) to settle briefly above its target range.

That sent shivers down some investors’ spines: A similar episode during the Global Financial Crisis (GFC) just over a decade ago reflected eroded confidence in the financial system: banks were faced with a sudden surge in uncertainty on the value of a wide range of assets as well as on counterparty risk. They reacted by hoarding liquidity.