In and Out Of Asia: The Affects of QE

In and Out Of Asia: The Affects of QE Brian Fabbri Visiting Research Fellow, CAMRI NUS Business School The St. Regis, Beijing October 14, 213

Issues to be Discussed 1. Why QE?: The zero interest rate boundary 2. What is QE? 3. How does it work? The transmission channels: banks, markets. 4. Has it been effective? It was inefficient, economy grew, inflation shifted to external markets. 5. Did the Fed achieve its objectives? 6. What will happen when QE ends? Policy turns back to FF rates management. 7. What s next? Forward Policy guidance and some predictions.

27-1 27-3 27-5 27-7 27-9 27-11 28-1 28-3 28-5 28-7 28-9 28-11 29-1 29-3 29-5 29-7 29-9 29-11 21-1 21-3 21-5 21-7 21-9 21-11 211-1 211-3 211-5 211-7 211-9 211-11 212-1 212-3 212-5 212-7 212-9 212-11 Why QE?: Central Bank s Lowered Rates to 6 Near Zero: The Zero Boundary 5 Fed funds 4 ECB 3 2 B of J 1

What is QE?: Massive Purchases of Securities by the Fed In QE1(Sep. 28-end-29) = $1.7tn Initially the Fed bought a variety of assets ( Treasury, agency, and agency mortgage-backed securities) Fed s assets almost triples from $8mn to $2.25tn QE2 (Nov. 21-June 211) = $6bn Concentrated on treasury securities, pushing Fed s assets to $2.7tn 4 3.5 3 2.5 Blue 6/25/28 Red: 9/19/213 Operation Twist (Sep. 211-Dec. 212) = $667bn Sale of short term securities to purchase longer-term debt to reduce long term interest rate 1 QE3 (Sep. 212 present) $4bn per month of additional openended MBS purchases raising total to.5 $85 bn per month. Total $3 tn. To date. Commitment to keep extremely low interest rate until at least mid-215 2 1.5 Bank Credit securities Treasuries Agencies MBS other

21-1-1 21-5-1 21-9-1 22-1-1 22-5-1 22-9-1 23-1-1 23-5-1 23-9-1 24-1-1 24-5-1 24-9-1 25-1-1 25-5-1 25-9-1 26-1-1 26-5-1 26-9-1 27-1-1 27-5-1 27-9-1 28-1-1 28-5-1 28-9-1 29-1-1 29-5-1 29-9-1 21-1-1 21-5-1 21-9-1 211-1-1 211-5-1 211-9-1 212-1-1 212-5-1 212-9-1 213-1-1 213-5-1 The Fed Wasn t the Only Central Bank Expanding its Balance Sheet 45. 4. 35. BoE 3. 25. 2. 15. ECB Fed Res 1. 5. BoJ.

199-1-1 1991-5-1 1992-9-1 1994-1-1 1995-5-1 1996-9-1 1998-1-1 1999-5-1 2-9-1 22-1-1 23-5-1 24-9-1 26-1-1 27-5-1 28-9-1 21-1-1 211-5-1 212-9-1 2-1 2-8 21-3 21-1 22-5 22-12 23-7 24-2 24-9 25-4 25-11 26-6 27-1 27-8 28-3 28-1 29-5 29-12 21-7 211-2 211-9 212-4 212-11 213-6 Bank Loan Growth Never Surged After QE (Yr/Yr % chgs.) 12 1 M2 y/y growth QE1 QE2 7 6 25 2 Before QE Real estate After QE 8 6 5 4 3 15 1 5 Total 4 2 M2 own rate 2 1-5 -1-15

199Q1 1991Q2 1992Q3 1993Q4 1995Q1 1996Q2 1997Q3 1998Q4 2Q1 21Q2 22Q3 23Q4 25Q1 26Q2 27Q3 28Q4 21Q1 211Q2 212Q3 Corporate Profits Soared in Past Few Years (Bils. $) 1,8. 1,6. 1,4. 1,2. 1,. Profits % of National Income 11. 1. 9. 8. Corporations profited highly during economic recovery when employment costs were very low. 8. 6. 4. 2. profits 7. 6. 5. Corporations had excess cash flow and didn t need to borrow.. 4.

199-1 1991-2 1992-3 1993-4 1994-5 1995-6 1996-7 1997-8 1998-9 1999-1 2-11 21-12 23-1 24-2 25-3 26-4 27-5 28-6 29-7 21-8 211-9 212-1 Banks Park Excess Reserves in Fed Funds Market and at Fed (Mil $) 2 18 16 14 12 1 8 6 4 2 Excess reserves Require reserves The Fed funded its security purchases by creating bank reserves, or base money. Banks used very little of these reserves to support money and credit growth. The excess reserves were mainly invested back to the Fed at the prevailing Fed funds rate around 12bp.

Has QE been Effective? Money supply and bank loans did not grow as rapidly as expected. Banks parked most of their reserves at the Fed instead of using them to fund loan creation. Financial market prices (bond yields, stock prices and the dollar) moved significantly as expected. The economy recovered, employment growth picked up and inflation decelerated. QE did offset effects from powerful fiscal restraint. Inflation decelerated throughout the period.

1984-1 1985-6 1986-11 1988-4 1989-9 1991-2 1992-7 1993-12 1995-5 1996-1 1998-3 1999-8 21-1 22-6 23-11 25-4 26-9 28-2 29-7 21-12 212-5 Real Rates Turned Negative in US 12. 1. 8. Real 1 yr. Treasury 6. 4. 2.. -2. real money market rates -4. -6. Fed rate cuts drove real rates negative and discouraged investment in money markets and bonds. Investors sought positive returns in higher risk securities. Money flowed into stocks, highly leveraged securities and foreign investments. Capital outflow propelled foreign stock and real estate prices higher.

1982q4 1983q3 1984q2 1985q1 1985q4 1986q3 1987q2 1988q1 1988q4 1989q3 199q2 1991q1 1991q4 1992q3 1993q2 1994q1 1994q4 1995q3 1996q2 1997q1 1997q4 1998q3 1999q2 2q1 2q4 21q3 22q2 23q1 23q4 24q3 25q2 26q1 26q4 27q3 28q2 29q1 29q4 21q3 211q2 212q1 212q4 S&P Index Grew Relative to GDP Since Onset of QE.16.14.12.1 Dot com bubble Credit bubble QE rise.8.6 S&P5/GDP.4.2

Real GDP In and Out of Recession (billions of 29 $, annualized quarterly growth rates) 158. 156. Q/Q rates of growth 6. 4. 154. 152. 15. 148. 146. 144. level 2.. -2. -4. -6. 142. -8. 14. -1.

26-1 26-5 26-9 27-1 27-5 27-9 28-1 28-5 28-9 29-1 29-5 29-9 21-1 21-5 21-9 211-1 211-5 211-9 212-1 212-5 212-9 213-1 213-5 Jan 26 Jul 26 Jan 27 Jul 27 Jan 28 Jul 28 Jan 29 Jul 29 Jan 21 Jul 21 Jan 211 Jul 211 Jan 212 Jul 212 Jan 213 Industrial Production and Capacity Utilization Back to Pre Recession Levels New House Sales (units AR)and Prices (FHFA index) Recovering 15 1 95 Industrial Production 1,3 1,1 24. 22. 9 9 2. 85 18. 7 8 16. 75 5 14. 7 65 6 Capacity Utilization 3 1 12. 1.

23/2 23/5 23/8 23/11 24/2 24/5 24/8 24/11 25/2 25/5 25/8 25/11 26/2 26/5 26/8 26/11 27/2 27/5 27/8 27/11 28/2 28/5 28/8 28/11 29/2 29/5 29/8 29/11 21/2 21/5 21/8 21/11 211/2 211/5 211/8 211/11 212/2 212/5 212/8 212/11 213/2 213/5 Monthly Employment Growth Averages 2k 6 4 Monthly changes 2-2 -4 6 month mov. Avg. -6-8 -1

1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 21 23 25 27 29 211 213 US Twin Deficits Improving (% NGDP) Gov t s Negative Contribution to GDP Growth 4 2-2 -4-6 -8-1 2.5 2. 1.5 1..5. -.5-1. -1.5-2. -12

21/1 21/5 21/9 22/1 22/5 22/9 23/1 23/5 23/9 24/1 24/5 24/9 25/1 25/5 25/9 26/1 26/5 26/9 27/1 27/5 27/9 28/1 28/5 28/9 29/1 29/5 29/9 21/1 21/5 21/9 211/1 211/5 211/9 212/1 212/5 212/9 213/1 213/5 Fed s Preferred Inflation Measure: Core PCE Below Target (% chg. YA) 3 2.5 Target 2% or slightly below 2 1.5 1.5

Forward Policy Guidance Fed now believes that what they say has more impact than what they do. Communication from Chairman will influence markets expectations and direction. Most of market s move will occur before well anticipated action. Keep rates low for a long time is example of guidance designed to flatten forward money market curve. QE taper before year-end is another example. Policy guidance is now both data and time dependent. Official Guidance will lead to more market volatility. Other central banks have followed Fed s example.

Stocks and Bonds Respond Quickly to Chairman s Comments 18 3 175 17 FOMC Announcement 2.8 2.6 165 16 S&P5 index 2.4 2.2 155 2 15 145 1 Yr. Treas. 1.8 1.6 14 1.4 135 1.2 13 1 8/9/12 9/9/12 1/9/12 11/9/12 12/9/12 1/9/13 2/9/13 3/9/13 4/9/13 5/9/13 6/9/13 7/9/13 8/9/13

May13 Jul13 Sep13 Nov13 Jan14 Mar14 May14 Jul14 Sep14 Nov14 Jan15 Mar15 May15 Jul15 Sep15 Nov15 Jan16 Mar16 May16 Jul16 Fed Funds Futures React to Fed s Guidance 1.8 1.6 1.4 1.2 1.8.6.4.2 June 2 Sep 26 May 21 Changes in policy guidance from Chm. Bernanke quickly altered market expectations for raising FF rate. Market now expects first hike in early 215 before stated FOMC policy guidance.

23-1 23-4 23-7 23-1 24-1 24-4 24-7 24-1 25-1 25-4 25-7 25-1 26-1 26-4 26-7 26-1 27-1 27-4 27-7 27-1 28-1 28-4 28-7 28-1 29-1 29-4 29-7 29-1 21-1 21-4 21-7 21-1 211-1 211-4 211-7 211-1 212-1 212-4 212-7 212-1 213-1 213-4 213-7 Falling Participation Biases Unemployment Rate 67. UR adjusted for stable Participation rate 12. 11. 66. 65. Participation Rate Left Unemployment rate right 1. 9. 8. 64. 7. 63. 6. 5. 62. 4. 61. 3.

23-1 23-4 23-7 23-1 24-1 24-4 24-7 24-1 25-1 25-4 25-7 25-1 26-1 26-4 26-7 26-1 27-1 27-4 27-7 27-1 28-1 28-4 28-7 28-1 29-1 29-4 29-7 29-1 21-1 21-4 21-7 21-1 211-1 211-4 211-7 211-1 212-1 212-4 212-7 212-1 213-1 213-4 213-7 Implied Inflation Remains Constant (1 yr. Tr. Inflation Indexed) 3.5 3 2.5 Implied Inflation 2 1.5 1.5 -.5 Real Interest rates -1

What s Next: Some Predictions More Forward guidance on tapering Federal Gov t shutdown will delay policy tapering. The beginning of tapering in Q1 214 The end of QE probably early 215. Raising the funds rate back to a neutral level: Late in 215. Tightening policy: raising the funds rate from neutral to tightening: 216 or later. Past tightening's have not been good for emerging markets: example 1994. All countries suffer capital outflow, those with CA deficits suffer most. Bigger pools of sovereign reserves (China, Japan) will limit damage, but not all Asian countries have sizable reserves.

Asian Stock Prices Fall on Taper Terror 155 145 May 22 135 125 115 Japan S&P 15 ASIA EX JAPAN 95 CHINA 85 75 1/2/13 2/2/13 3/2/13 4/2/13 5/2/13 6/2/13 7/2/13 8/2/13 INDIA

Recent Volatility of Emerging markets ETFs Greater Than S&P S&P blue Emerging Markets

US Private Investors Continued to Invest Abroad in Q2 213 15. 1. 5. Disinvestment Foreign Securities. -5. -1. -15. -2. Investment Direct investment

1/1/7 6/1/7 11/1/7 4/1/8 9/1/8 2/1/9 7/1/9 12/1/9 5/1/1 1/1/1 3/1/11 8/1/11 1/1/12 6/1/12 11/1/12 4/1/13 9/1/13 Big Shift in US Mutual Fund Investment in 213 ($bils.) 6 4 2-2 -4-6 -8 Bond funds International funds US investors sold bond funds heavily in 213. But kept purchasing International funds through entire period. US private investors made long term investments abroad throughout 213. US companies continued making Direct Investment. US did not sell Asian markets in Q2 213. Asians panicked in Q2 and sold their own markets!

1991-1 1991-4 1991-7 1991-1 1992-1 1992-4 1992-7 1992-1 1993-1 1993-4 1993-7 1993-1 1994-1 1994-4 1994-7 1994-1 1995-1 An Unexpected Tightening in 1994 9 8 7 6 1 yr. Tr. Rates FOMC raises In Feb. 1994 after years of accommodative monetary policy the FOMC decided to raise rates. 5 4 3 After 1 year the Fed raised rates by 25bp, much more was to follow. 2 1 Fed Funds rate Bond yields soared by more than 25bp, and quality spreads widened.

Asian Countries with Biggest CA Deficits Are Most Vulnerable (bil $) 6 4 2-2 brunei philippines singapore indonesia malaysia thailand myramar cambodia laos vietnam hong kong india -4-6 -8-1 -12

Asian Sovereign Wealth Funds and FX Reserves Are Bigger Now ($bil.) 6 5 4 3 2 1

Expected Market Impacts from Tapering to Tightening The dollar will appreciate as the Fed restricts the supply and demand will rise in a flight back to quality. Emerging markets suffer increased volatility, FX depreciation and stock price declines. Interest rates in US will rise up to normal levels that reflect the strength of economic growth and inflation. Bond rates would also reflect a normal term premium. The yield curve steepens ahead of the Fed s decision to tighten policy. The return to neutral monetary policy has a muted effect on US stock prices as economic growth maintains corporate profitability. A future decision to tighten policy from neutral will depress stock prices everywhere.