The effect of QE3: Low bond yields
October employment report: Numbers are alarming (Part 3 of 5)
There are two distinct but closely related problems. First, the benefits of Fed policy have reached their limits.%Cnto the sunset, it overstayed its welcome and has distorted asset prices and capital allocation decisions profoundly.
Market Realist – Aggressive bond buying by the Fed has led to low bond yields
The Federal Reserve (the Fed) introduced quantitative easing (or QE) during the Great Recession in the late 2000s to stimulate consumption and investment in the ailing U.S. economy. There were three rounds of the QE in which the Fed bought Treasuries (TLT)(IEF) and mortgage-backed securities (or MBS) of different maturities. This pumped money into the system.
The bond buying program has brought the economy back on the growth track. This has helped U.S. equities (SPY) reach all-time highs in 2014. However, it came with some side-effects.
As you can see in the graph above, ten-year Treasuries and AAA-rated corporate bonds (LQD) are yielding very little compared to what they used to. The Fed bought a massive number of longer-term Treasuries and MBS worth $1.7 trillion in QE3. This drove bond yields down due to supply-demand mechanics.
In their pursuit of yield, investors have purchased riskier assets like Greek bonds and high-yield bonds (JNK), which has helped credit spreads reach all-time lows.
Companies may be sitting on a lot of cash, but due to uncertainty over organic economic growth levels and aggregate demand, they are wary of using it to make more permanent investments in growth.
Browse this series on Market Realist:
