Evaluating Central Bank Quantitative Easing Impact

A risk management cut? By now, the asymmetry of central bank reaction function isn’t lost on anyone. If you invest or manage money, consider the following framework: Liquidity Tailwinds: Broad-based easing at this stage of the cycle has historically supported a powerful run in risk assets, often extending valuations beyond fundamentals. Policy Asymmetry: With debt loads high and fiscal deficits widening, central banks may be forced to ease more aggressively than in past cycles to cushion financing costs. The marginal impact of liquidity could be even greater. Exit Risk: If growth and liquidity peak together, the eventual policy reversal tends to be sharper. Positioning needs to account for an abrupt shift in the rates once inflation reasserts. In short: global liquidity is surging into expansion. That usually drives another leg higher for risk assets but it also plants the seeds for more volatility down the road. The key CIO question: how much of this liquidity do you want to ride, and how quickly can you pivot when the tide turns?

Modern central banking has changed dramatically since 2008. Beyond setting interest rates, central banks now wield trillions in asset purchases and subsidised loans, actions often presented as technical fixes. However, as our new book "Crisis Cycle" explains, these policies are engines of wealth redistribution, creating winners and losers while distorting market incentives. We highlight three key channels: * The Great Risk Transfer: Quantitative Easing (QE) directly benefits bondholders and shifts significant duration risk from private markets to taxpayers. When rates rise, as they did recently, taxpayers bear the losses. * An Exclusive Club: Central banks pay interest on bank reserves, a safe and liquid asset, excluding ordinary citizens and businesses. This creates an imbalance, allowing banks to earn risk-free income while retail savers get far less. * The Stealth Bank Bailout: Programs like TLTROs offer banks exceptionally low-cost funding, even allowing them to profit by redepositing funds with the central bank. This indirect subsidy, coupled with broad collateral rules, distorts market discipline and transfers risk to taxpayers. These "emergency" measures risk becoming permanent, fostering a "collective moral hazard" where institutions expect bailouts, delaying necessary reforms. It's time to debate these hidden costs and ensure parliaments, not central banks, make decisions about risk and wealth distribution. Read more about these hidden costs and their implications: https://lnkd.in/dD4K6Prh

QE Was Never Just Monetary Policy For years, quantitative easing was sold as a technical instrument. Central banks bought bonds. Yields fell. Financial conditions eased. Economies recovered. But the real story was always bigger. QE sits at the uncomfortable frontier between monetary policy and fiscal policy. A new IMF paper by Tobias Adrian, Christopher Erceg, Marcin Kolasa, Jesper Lindé and Pawel Zabczyk makes an important point: QE should not be judged only by the accounting losses of central banks. It should be judged by its macroeconomic and fiscal consequences. That distinction matters. In a deep liquidity trap, QE can support output, raise inflation toward target, and even improve the consolidated fiscal position of the state by helping the economy recover faster and reducing the debt burden. But the paper also gives a warning. QE is much more dangerous when the economy is only in a shallow liquidity trap. In that case, the same instrument that supports recovery can also overheat the economy, fuel inflationary pressure, and generate large central bank losses. The lesson is not that QE was a mistake. The lesson is that QE is powerful, state-contingent, and deeply fiscal in its consequences. Central bank losses are not irrelevant. They can matter if they weaken credibility, invite political pressure, or blur the boundary between monetary independence and fiscal dominance. But judging QE only through the lens of central bank profits and losses misses the larger picture. The real question is not: did the central bank lose money? The real question is: did the policy stabilize the economy, preserve credibility, and improve the consolidated balance sheet of the public sector? That is the debate policymakers should be having. QE was never just about bond markets. It was about the state’s capacity to manage crises when interest rates hit the floor. And as the next downturn approaches, the challenge will not be whether to use QE again. It will be how to use it with more discipline, clearer exit rules, and a better understanding of its fiscal footprint. Monetary policy ends where fiscal consequences begin. Read the paper here: https://lnkd.in/dmzNmaJp #MonetaryPolicy #FiscalPolicy #QuantitativeEasing #CentralBanks #Macroeconomics #Inflation #PublicDebt #FinancialStability

Seth Carpenter, MS | The Great Unwind Four key observations: - QT is not the opposite of QE. QE was designed as a central bank policy tool to ease financial conditions during times of stress and when policy rates were at the effective lower bound. Central banks were trying to signal a commitment to ease, stimulate borrowing, boost credit supply, and lower longer-term rates. QT continues even as central banks are contemplating rate cuts, so no signaling is involved. Much of QT is taking place passively, with federal debt issuance replacing central bank holdings that mature. Outright sales by central banks have been absorbed easily because of the more stable environment. And even if the dollar-for-dollar effect of these sales were the same (which is not the case), most central banks will not be fully unwinding the expansion of their balance sheets. - Central bank balance sheets differ substantially across economies. Central banks must cater to local preferences. The US is a capital markets-focused economy, and most of the balance sheet expansion came through purchases of Treasuries and MBS. The euro area, by contrast, is much more bank dependent, so in addition to QE the ECB deployed massive targeted longer-term refinancing operations (TLTROs) in direct funding through banks. The composition of their balance sheets was thus quite different. In a period of QT, while the market does have to absorb the purchased securities that run off central bank balance sheets, there are no analogous market implications when euro area banks unwind TLTROs. - Central banks can clearly experience losses. By construction, as central bank assets rose, so did their liabilities. The assets in general paid a fixed coupon, while the liability cost rose with policy rates. The unsurprising consequence has been negative net income, particularly for the Fed and the ECB. The BoE suffered losses on its QT, but it has an explicit indemnification agreement with the Treasury. The Czech central bank has famously operated for years with negative net equity. In general, central bank P&Ls lack macroeconomic implications, although political considerations can accrue over time. - Balance sheets will shrink substantially but should not revert to past levels. Larger balance sheets are the new normal, and both the Fed and the ECB have codified “floor systems” in their plans. We are in for a period of central bank balance sheet contraction, but we will not get back to the levels seen before the global financial crisis. #centralbanks #fed #ecb #boe #boj #monetarypolicy #balancesheet #interestrates #qt #qe

In his latest policy statement, the RBI Governor outlined how the 100 basis points (bps) cut in the policy repo rate during the current easing cycle has been transmitted across different segments of the financial system. Money Market: Following the cumulative 100 bps cut, the weighted average call rate (WACR) eased by 108 bps. Since the February policy, the 3-month Treasury Bill yield has fallen by 110 bps, the 3-month commercial paper (CP) rate for NBFCs by 161 bps, and the 3-month certificate of deposit (CD) rate by 170 bps. This shows a rapid pass-through in short-term funding costs. Bond Market: Government securities have reacted, though with varying intensity. The 5-year G-Sec yield has dropped by 63 bps, while the 10-year benchmark (6.79 GS) yield is down by 28 bps since February. Corporate debt markets mirrored this trend, with 5-year AAA-rated corporate bond yields falling by 56 bps, signalling improved financing conditions for high-quality issuers. Credit Market: In lending, the weighted average lending rate (WALR) of scheduled commercial banks declined by 71 bps for fresh rupee loans between February and June 2025, with 55 bps of this directly due to policy rate cuts. For outstanding rupee loans, the WALR moderated by 39 bps in the same period. On the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits eased by 87 bps, reflecting lower funding costs for banks. Other Channels: While the Governor did not specifically mention them, transmission is also operating through the exchange rate and asset price channels, as seen in movements in the forex market and equity valuations. Together, these developments suggest that the RBI’s earlier rate cuts are steadily permeating the economy, though the complete effects,especially in retail credit, are still unfolding.

Central banks did not just influence markets. They redefined how assets are priced. The prevailing assumption is that asset prices are primarily driven by fundamentals; cash flows, earnings, and growth expectations. Monetary policy is seen as a background variable that adjusts conditions but does not dominate valuation. That assumption weakens in a liquidity-driven regime. When central banks lower rates, expand balance sheets, and compress yields, the discount rate applied to future cash flows changes across the entire system. Asset prices rise not only because earnings improve, but because capital has fewer alternatives. The deeper mechanics are structural. Lower rates increase the present value of future cash flows. Quantitative easing injects liquidity that must be allocated somewhere. Yield compression pushes investors into riskier assets in search of return. Volatility suppression encourages leverage and duration extension. These forces alter price discovery. Markets begin to respond more to policy signals than to underlying fundamentals. Liquidity conditions shape valuations as much as earnings trajectories. The second-order effect is dependency. When asset prices are supported by abundant liquidity, normalization becomes destabilizing. Rising rates reverse the same mechanisms that elevated valuations. Correlations shift. Assets that were diversified begin to move together. The implication for boards and capital allocators is structural. Valuation cannot be understood without understanding the policy environment that supports it. The question is not whether central banks will continue to influence markets. It is how asset pricing will adjust when liquidity is no longer the dominant driver.

If long-end bond yields spiral out of control, the Fed could start injecting liquidity again: a step-by-step guide of how it works. When a few weeks ago 30-year bond yields briefly flirted with the 5% level, the Fed's Collins released an interview stating that ''the Fed is absolutely ready to stabilize markets''. To stabilize the bond market, they would ''inject liquidity'' through operations like the LSAP - Large Scale Asset Purchase or QE. Central Banks create bank reserves when they perform such operations. Bank reserves are often referred to as ''Liquidity''. When Central Banks engage in liquidity creation, they do that in the hope that it activates the so-called Portfolio Rebalancing Effect. To understand this, let’s start from what QE does to the balance sheet of a commercial bank - take a look at the chart below. Following the GFC, regulators forced banks to own more HQLA (high quality liquid assets) to meet depositor outflows. Bank reserves and bonds qualify as ''HQLA'' as they are liquid enough to be converted in cash to meet potential outflows quickly. But banks are not indifferent between owning bank reserves and bonds, and especially if the amount of reserves grows dramatically as a result of QE. Bank reserves are a zero-duration and low-yielding instrument which can be suboptimal to own in big sizes especially if compared with bonds which offer higher returns and duration hedging properties. And this is when the Portfolio Rebalancing Effect kicks in. Once QE starts, Central Banks take away bonds and inject new reserves in the banking system. Loaded with suboptimal reserves, banks will try to switch back the composition of their portfolios towards more bonds. They will bid up safer bonds first, and bid up riskier bonds later when the hunt for returns intensifies. This will kick in a virtuous cycle of low volatility and a hunt for riskier assets: the Portfolio Rebalancing Effect in action. Summarizing: 1️⃣Central Banks expand their balance sheet and purchase bonds 2️⃣Commercial Banks are on the receiving end of QE, and hence their portfolio composition tilts towards more reserves, and less bonds; 3️⃣But reserves are sub-optimal to own compared to regulatory-friendly bonds, and hence they look to rebalance their portfolios; 4️⃣They start buying the very same bonds QE is buying, hence suppressing volatility further and compressing credit spreads; 5️⃣Asset allocators and investors across the world are more and more encouraged to take additional risks in their portfolio, supporting the flow of credit and capital. Does the Portfolio Rebalancing Effect make sense to you? 👉 If you enjoyed this post, follow me (Alfonso Peccatiello) to make sure you don't miss my daily dose of macro analysis.

🍁 𝗧𝗵𝗲 𝗕𝗮𝗻𝗸 𝗼𝗳 𝗖𝗮𝗻𝗮𝗱𝗮 & 𝗚𝗼𝘃𝗲𝗿𝗻𝗺𝗲𝗻𝘁 𝗥𝗲𝗹𝗶𝗲𝗳 𝗣𝗿𝗼𝗴𝗿𝗮𝗺𝘀: The Bank of Canada stated today: "𝙏𝙝𝙚 𝙗𝙖𝙧 𝙛𝙤𝙧 𝙪𝙨𝙞𝙣𝙜 𝙦𝙪𝙖𝙣𝙩𝙞𝙩𝙖𝙩𝙞𝙫𝙚 𝙚𝙖𝙨𝙞𝙣𝙜 (𝙌𝙀) 𝙨𝙝𝙤𝙪𝙡𝙙 𝙧𝙚𝙢𝙖𝙞𝙣 𝙫𝙚𝙧𝙮 𝙝𝙞𝙜𝙝 𝙜𝙤𝙞𝙣𝙜 𝙛𝙤𝙧𝙬𝙖𝙧𝙙." This means that if the government runs a large deficit to fund COVID-style relief for potential 25% U.S. tariffs, without QE, bond yields will rise significantly, increasing interest costs for taxpayers. 📌 𝗞𝗲𝘆 𝗗𝗲𝗳𝗶𝗻𝗶𝘁𝗶𝗼𝗻𝘀: 🔹 𝗤𝘂𝗮𝗻𝘁𝗶𝘁𝗮𝘁𝗶𝘃𝗲 𝗘𝗮𝘀𝗶𝗻𝗴 (𝗤𝗘): The central bank buys government bonds to inject liquidity, lower interest rates, and encourage borrowing. 🔹 𝗤𝘂𝗮𝗻𝘁𝗶𝘁𝗮𝘁𝗶𝘃𝗲 𝗧𝗶𝗴𝗵𝘁𝗲𝗻𝗶𝗻𝗴 (𝗤𝗧): The central bank sells or stops reinvesting bonds, reducing liquidity and increasing interest rates to control inflation. 📢𝗕𝗮𝗻𝗸 𝗼𝗳 𝗖𝗮𝗻𝗮𝗱𝗮 (𝗕𝗼𝗖) 𝗔𝗻𝗻𝗼𝘂𝗻𝗰𝗲𝗺𝗲𝗻𝘁𝘀:  The BoC confirmed it will end QT in less than two months and emphasized: "We are a long way from needing quantitative easing. Our policy rate is at 3%. We recently published a review of extraordinary measures used during COVID. What we concluded was that the bar for using quantitative easing in Canada has always been very high. In fact, we have only used it once—during a once-in-a-century pandemic. The bar for using quantitative easing should remain very high going forward." 📉 𝗚𝗼𝘃𝗲𝗿𝗻𝗺𝗲𝗻𝘁 𝗥𝗲𝘀𝗽𝗼𝗻𝘀𝗲 𝘁𝗼 𝟮𝟱% 𝗨.𝗦. 𝗧𝗮𝗿𝗶𝗳𝗳𝘀: Several government officials have suggested pandemic-style relief programs to offset potential tariffs. However, BoC is unlikely to support fiscal stimulus through QE this time due to: ✅ The $130B gap in the size of its balance sheet from the pre-pandemic baseline. ✅ A weakening CAD, which could fuel import-driven inflation. ✅ The need to restore monetary stability post-COVID. This means funding large relief programs will be much harder than before. 💰𝗜𝗺𝗽𝗮𝗰𝘁 𝗼𝗻 𝗚𝗼𝘃𝗲𝗿𝗻𝗺𝗲𝗻𝘁 𝗕𝗼𝗻𝗱𝘀: • In pandemic relief programs, the government issued bonds, and the BoC was a key buyer, helping to keep yields low. • Without QE, the government may struggle to sell bonds, forcing it to offer higher yields to attract investors. • Higher yields = More interest costs for taxpayers. ⏳𝗜𝗻 𝗦𝗵𝗼𝗿𝘁: If the government implements COVID-like relief programs without BoC support, it will likely face significantly higher interest costs on newly issued bonds. However, it's important to note that predicting the BoC’s response this time remains uncertain. ________________________ Provided by WOWA.ca Simply Know Your Options🔍

Bank of England Quantitative easing and quantitative tightening: the money channel We develop a DSGE model in which commercial banks interact with the central bank through the reserves market, with each other through reserves and interbank markets, and with the real economy through retail loan and deposit markets. Because banks disburse loans through deposit creation, they never face financing risks (being unable to fund new loans), only refinancing risks (being unable to settle net deposit withdrawals in reserves). Permanent quantitative tightening, while reducing the equilibrium real interest rate, has significant negative effects on financial and real variables, by increasing the cost at which reserves-scarce parts of the banking sector create money. Temporary net deposit withdrawals, which affect the funding cost and loan extension of one part of the banking sector at the expense of another part, have highly asymmetric financial and real effects. The quantity and distribution of central bank reserves, and the extent of frictions in the interbank and reserves markets, critically affect the size of these effects, and can matter even in a regime of ample aggregate reserves. Countercyclical reserve injections can help to smooth the business cycle. We find that countercyclical reserve quantity rules can make sizeable contributions to welfare that can reach a similar size to the Taylor rule.

🎈 𝗧𝗛𝗘 "𝗙𝗘𝗗 𝗣𝗨𝗧" This week being a "Central Banks week", I though i would recommend the reading of a paper about a very specific "derivatives": "The Fed Put". 𝗦𝗶𝗻𝗰𝗲 𝘁𝗵𝗲 𝗺𝗶𝗱-𝟭𝟵𝟵𝟬𝘀, 𝘁𝗵𝗲 𝗙𝗲𝗱𝗲𝗿𝗮𝗹 𝗥𝗲𝘀𝗲𝗿𝘃𝗲 𝗵𝗮𝘀 𝘀𝘆𝘀𝘁𝗲𝗺𝗮𝘁𝗶𝗰𝗮𝗹𝗹𝘆 𝗲𝗮𝘀𝗲𝗱 𝗺𝗼𝗻𝗲𝘁𝗮𝗿𝘆 𝗽𝗼𝗹𝗶𝗰𝘆 𝗳𝗼𝗹𝗹𝗼𝘄𝗶𝗻𝗴 𝘀𝘁𝗼𝗰𝗸 𝗺𝗮𝗿𝗸𝗲𝘁 𝗱𝗲𝗰𝗹𝗶𝗻𝗲𝘀. A study by Cieslak and Vissing-Jorgensen (RFS 2021) finds that a 10% drop in stock prices leads to a 1 percentage point downgrade in the Fed’s GDP growth expectations, increasing the likelihood of a rate cut. This response is asymmetric—𝗻𝗲𝗴𝗮𝘁𝗶𝘃𝗲 𝘀𝘁𝗼𝗰𝗸 𝗿𝗲𝘁𝘂𝗿𝗻𝘀 𝗼𝗳𝘁𝗲𝗻 𝗹𝗲𝗮𝗱 𝘁𝗼 𝗲𝗮𝘀𝗶𝗻𝗴, 𝗯𝘂𝘁 𝗽𝗼𝘀𝗶𝘁𝗶𝘃𝗲 𝗿𝗲𝘁𝘂𝗿𝗻𝘀 𝗱𝗼 𝗻𝗼𝘁 𝗿𝗲𝘀𝘂𝗹𝘁 𝗶𝗻 𝘁𝗶𝗴𝗵𝘁𝗲𝗻𝗶𝗻𝗴. 📃 Textual analysis of FOMC minutes (1994–2016) confirms that the Fed actively monitors stock market movements. Mentions of 𝘀𝘁𝗼𝗰𝗸 𝗱𝗲𝗰𝗹𝗶𝗻𝗲𝘀 𝘀𝘁𝗿𝗼𝗻𝗴𝗹𝘆 𝗽𝗿𝗲𝗱𝗶𝗰𝘁 𝗿𝗮𝘁𝗲 𝗰𝘂𝘁𝘀, with discussions focused not just on market signals but on their perceived economic impact. The main concern is consumption: 𝗳𝗮𝗹𝗹𝗶𝗻𝗴 𝘀𝘁𝗼𝗰𝗸 𝗽𝗿𝗶𝗰𝗲𝘀 𝗿𝗲𝗱𝘂𝗰𝗲 𝗵𝗼𝘂𝘀𝗲𝗵𝗼𝗹𝗱 𝘄𝗲𝗮𝗹𝘁𝗵, 𝗹𝗲𝗮𝗱𝗶𝗻𝗴 𝘁𝗼 𝘄𝗲𝗮𝗸𝗲𝗿 𝘀𝗽𝗲𝗻𝗱𝗶𝗻𝗴. Investment constraints also play a role, though to a lesser extent. This shift in policy focus emerged in the mid-1990s, coinciding with changes in Fed modeling and communication strategies. Before that period, stock market declines did not systematically influence policy decisions. The study also finds that the Fed’s response to stock declines is similar in magnitude to private sector forecasts, suggesting it is not an overreaction but a reflection of its economic outlook. Beyond rate cuts, the Fed Put extends to forward guidance and other policy tools, including quantitative easing, particularly at the zero lower bound. 𝗠𝗮𝗿𝗸𝗲𝘁 𝗽𝗮𝗿𝘁𝗶𝗰𝗶𝗽𝗮𝗻𝘁𝘀 𝗵𝗮𝘃𝗲 𝗰𝗼𝗺𝗲 𝘁𝗼 𝗲𝘅𝗽𝗲𝗰𝘁 𝘁𝗵𝗶𝘀 𝗿𝗲𝗮𝗰𝘁𝗶𝗼𝗻, raising questions about whether it reduces economic volatility or encourages excessive risk-taking. 📖 Source: Cieslak, A., & Vissing-Jorgensen, A. (2021). The Economics of the Fed Put. The Review of Financial Studies #fed #fedput #derivatives