“I don’t think there is any doubt that quantitative easing enabled the rich and the quick. It was a massive gift,” said Dallas Fed President Richard Fisher in his speech at the London School of Economics on Monday, March 24. He cited the example of how ten-year Treasuries were used by markets as a benchmark to discount future cash flows. The low-rate environment has led to a concentrated wealth effect, which is evident in the returns announced by some private equity firms and private individuals.
How did investors in stock and bond markets benefit from the Fed’s accommodative monetary policy?
The S&P 500 Index (SPY) increased to 1,854.29—an all-time high—on February 27, 2014, on Federal Reserve Chair Janet Yellen’s testimony to the Senate Banking Committee. Yellen reiterated that the Fed’s commitment to the taper was unchanged and that the Fed would gauge the impact of poor weather on recent disappointing economic data before modifying the pace of asset purchases. This was after the index (SPY) had already clocked returns in excess of 15% in 2012 and 32% in 2013. One ETF providing exposure to the S&P 500 Index is the State Street SPDR S&P 500 ETF (SPY). The top holdings in SPY include banking behemoths JP Morgan (JPM) and Wells Fargo (WFC).
Fixed income investors also gained from the falling interest rate environment the Fed created. The iShares 20+ Year Treasury Bond ETF (TLT) gained almost 34% over from 2008 to 2013, while the Vanguard Total Bond Market ETF (BND) gained ~9% over the same period.
How has increasing wealth concentration impacted risk-taking?
Fisher also said QE has enabled “corporations to become muscular financially, rebalance their balance sheets,” and be prepared to create jobs, which they haven’t done as yet. This has led to some instances of excessive risk—like stock market capitalization relative to overall GDP, the bull-bear spread, and margin accounts again at historic highs. But most importantly, looking at the credit markets, in Fisher’s opinion, is the most important tool in assessing the efficacy of what the Fed does. We’re seeing extraordinarily low interest rates, historically low credit spreads between junk CCC rated-debt, and most importantly, extremely low investment-rate yields.
Quantitative easing and the wealth effect
Fisher cited a study by the Bank of England that estimated that the QE’s distribution of wealth effect in the UK achieved 40% of what the bank wanted to achieve. While Fisher didn’t cite comparable figures for the U.S., he said the wealth effect was “heavily concentrated” and was one of the bigger disappointments of QE. He said income distribution was a concern, “especially the efficacy of QE 3 is still debatable in terms of its impact on income distribution.”
The main challenge remains for the Fed now to be able to “properly articulate their concerns and provide forward guidance.”
While QE has made markets somewhat sanguine over the past few years, read the next part of this series to find out why Richard Fisher thinks volatility can be a good thing for markets.