Last year, in November, the US Federal Reserve (Fed) announced its second round of quantitative easing (QE2) of USD 600 billion to support the struggling US economy. The QE2 plan included purchase of treasury bonds of around USD 75 billion per month for the last eight months to increase money supply in the system. The QE2 term is coming to an end this month. Analysts are analysing the various economic factors after the QE2 term in the US.
Initial expectations from QE2
The main objective of the Fed while launching QE2 was to stimulate economic activity by cutting down interest yields on bonds, and thereby forcing investors to invest in riskier assets such as equity. The idea was that this would in turn create a wealth effect and result in more consumer-spending, which would inflate the economy. Also, the continued low interest rates would help in servicing interest payments of the federal deficit.
Here is an analysis of the expected impact after QE2:
Global equity and commodity markets
The equity and commodity markets globally outperformed after the announcement and during the phase of the quantitative easing. Although the discontinuation of QE2 does not mean the stock markets will crash, it is certainly a negative development for the markets.
As the interest rates are expected to go up after QE2 is withdrawn, some liquidity is expected to move from domestic equity to the safer debt-based instruments.
Interest rates
One of the most significant results of QE2 was the softening of interest rates on bonds. Analysts believe the Fed not buying now will result in interest rates hardening in the medium term. However, a hardening of interest rates will lead to more economic activity and demand for money, going forward.
If economic activity does not pick up without the artificial support of QE2, it signals further problems with the economy and may warrant another round of stimulus package.
Impact on dollar
The weakness in the US dollar against major world currencies was another much-expected outcome of QE2. The Fed expected a weak dollar to help in changing trade imbalances. Although the dollar strengthened in the beginning due to other developments at the global level, it started weakening during the last couple of months. The trade deficit of the US also saw a drop last month. The dollar is expected to remain range-bound in the short term.
Possibility of QE3
Although it is a bit early to make a detailed analysis, the economic data available suggests the expected outcome of QE2 has not happened and some economists feel a need for QE3. However, analysts feel the Fed would like to watch the developments on various economic factors in the absence of a stimulus package and then decide on the future course of action.
Investors should track post QE2 scenario
Investors should track the various economic data points in the US. The developments around these quantitative easing packages can keep the markets volatile in the short term.
It is not easy to predict the outcome and scenario after the end of QE2 accurately due to complex nature of the monetary policy and its impact. It seems possible the interest rates will tend to move upwards, and stocks and commodity markets may have some profit booking in the short to medium terms, due to a realignment of some risk capital in the markets.
