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How Does Quantitative Easing Impact Interest Rates?

It is quite rational to assume that bond prices will go up and yields will go lower when the Federal Reserve purchases billions of dollars of US Treasuries and other government-backed bonds on a monthly basis for an unlimited period of time. The only problem with this assumption is that it is clearly not working out that way. In fact, the exact opposite is occurring!

With each and every round of quantitative easing (aka the Fed goes on a massive buying spree of government bonds with money created out of thin air), bond prices have actually dropped and interest rates have gone up. And every single time a round of quantitative easing has come to an end, bond prices have gone up sending interest rates lower. Every single time. See the chart below of the 10 Year and 30 Year US Treasury Bond yields for the evidence. Each grey area indicated on the chart represents a round of quantitative easing or similar financial engineering from the Fed.

10 and 30 Year US Treasury Bond Yields

So how does this impact you and me? Well, first of all, it means that Federal Reserve tapering (slowing or reducing future QE) does not necessarily mean that interest rates are going much higher as everyone is currently expecting. If history is any guide, it may mean the very opposite.

Second, at or around the end of each round of QE, the stock market suffered a decent sized correction. (I suppose it is hard to avoid the deflationary hangover when they remove the perception of the cheap money punchbowl!) Therefore, equity market caution is warranted.

Hat tip to Van R. Hoisington and Lacy H. Hunt, Ph.D. for initially pointing out this counterintuitive reality.

Written By: Joshua Ungerecht

10 Year Bond, 30 Year Bond, Federal Reserve, interest rates, Lacy H. Hunt, Ph.D., QE1, QE2, QE3, Quantitative Easing, Stock Market, US Treasuries, Van R. Hoisington