Do You Believe In Magic? by Brent Donnelly
How reliable is the link between the Fedís balance sheet and US equities? Find out here.
...I worry about the effects on the long-run stability and efficiency of our financial system if the Fed attempts to substitute its judgments for those of the market. Such a regime would only increase the unhealthy tendency of investors to pay more attention to rumors about policymakersí attitudes than to the economic fundamentals that by rights should determine the allocation of capital.
óBen Bernanke, October 15, 2002
Quantitative easing (QE) is a fairly new development in the financial markets. Hence, analysts should be open-minded and maintain healthy skepticism when it comes to attributing causal links between the size of the Federal Reserveís balance sheet and the level of various financial asset prices and inflation. In contrast to such healthy skepticism, the market has generally tended to adopt a religious fervor around QE and then quickly abandon that fervor once the empirical evidence fizzles. There have been many examples of this since 2008.
QUANTITATIVE EASING AND ASSET PRICES
First, the market believed strongly in 2008 and 2009 that US QE would lead to a substantial depreciation of the US dollar. The announcement of QE1 in March 2009 encouraged that viewpoint as the US dollar cratered for most of 2009. But then, very quickly, the relationship between the US dollar and the Fedís balance sheet (if there ever was one) fizzled (Figure 1).