J.P. Morgan: Mulling the Headwinds of QE2′s End

J.P. Morgan: Mulling the Headwinds of QE2′s End

  • Posted Friday, May 20, 2011 -
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AP QE2′s cruise coming to an end.

The Federal Reserve's latest Quantitative Easing/Bond Buying program (QE2) winds down next month, and folks are trying to figure out what that means for the financial markets.

Yesterday, Matt had a nice round-up of what the chin-scratchers are thinking about QE2′s end. Today, J.P. Morgan has a note out today trying to solve the QE2 mystery. The main points:

  • During QE2 and its predecessor, QE1, "real bond yields appear to have declined and price-to-earnings ratios appear to have increased" and some of those moves were "partly reversed after QE1 ended. With the caveat that factors other than QE, such as fiscal policy, might have affected bond and equity prices, [the QE1 experience] raises concerns about both bonds and equities performance after the end of QE2."
  • QE "stimulates demand for other fixed income sectors as well." QE1 helped re-open bond markets after the worst of the financial crisis, and issuance slowed after QE1 ended in March 2010. "Debt issuance by corporatesrebounded after QE2 began in Nov. 2010. To the extent that the end of QE2 results in reduced corporate debt issuance and slower corporate expansion, it would represent a headwind for both the economy and equity markets."
  • QE also boosts cash balances. Deposits increased strongly during QE1 and QE2, but slacked off in between the two QE periods. "Higher cash balances induce investors to push the prices of other assets, such as bonds and equities, higher in seeking to reduce their cash overweight. Slower money supply growth reduces the impact of this force."

Translation: the end of the Fed's QE2 splurging will make the going a bit tougher. At least according to JPM.

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