How end of Fed QE2 will affect stock market

Back in late 2008, the first true stock panic in 101 years crushed the global stock markets. In October alone, the flagship S&P 500 stock index (SPX) plummeted 30% in just 4 weeks! This epic bloodbath drove widespread fears of a new global depression, which the Fed wanted to fight at all costs. So on December 16th, 2008, the Fed’s Federal Open Market Committee slashed its overnight federal-funds rate by over 0.75% to an unprecedented “target range” between zero and 0.25%.

With its primary interest rate already at zero, the Fed had expended all its normal ammunition with nothing left for the future. Its only option left was to directly buy securities, artificially boosting demand by creating new US dollars out of thin air to monetize assets. Thus “quantitative easing” was born, a desperate last-ditch strategy historically used by third-world banana republics just before their currencies fail and hyper-inflate. It was a sad moment for the world’s biggest central bank managing the world’s reserve currency.

This first chart highlights the Fed’s monetization since this fateful decision was made in late 2008. The Fed’s total balance sheet, including all the securities it was buying, is shown in orange. The main types of debt it purchased are US Treasuries (red), mortgage-backed securities (yellow), and agency debt (green). Note that these three QE components are shown in area fashion, stacked on top of each other. The red Treasury series, for example, does not run from zero but from the top of the yellow MBS series.

While it wasn’t yet called quantitative easing, this whole inflationary monetization was born on November 25th, 2008 several days after the primary stock-panic low. Even though the SPX had already bounced 13.9% higher, the Fed announced it would purchase up to $500b of mortgage-backed securities issued by Fannie Mae, Freddie Mac, and Ginnie Mae to attempt to ease up credit for the housing market. It also said it would buy up to $100b of bonds directly from these government-sponsored enterprises, GSE agency debt. It said these purchases would take several quarters.

Realize that the stock markets are the key to the entire economy. When they are rising, everyone feels better and more optimistic regardless of whether they are an investor or not. When they are falling, everyone feels worse and more pessimistic so they slow down their economic activity. There is no doubt the post-panic stock markets would have bounced sharply higher anyway, but the Fed hoped its initial foray into monetization would accelerate this process.

And indeed in December 2008, the stock markets stabilized and started climbing again. But in January and especially February 2009, this recovery process ground to a halt. The new Obama Administration was terrifying investors with its Marxist plans to socialize medicine and radically raise already-crushing income taxes on the investors, entrepreneurs, and small businessmen who create most of the private-sector jobs in America. So the SPX plunged sharply again on this Democrat Despair, falling 25.1% year-to-date by early March.

Once again the Fed panicked, worried that the dismal stock-market action would scare and depress Americans into seriously reducing their spending. This would have spawned a depression. So on March 18th, 2009, over a week after those secondary lows in which the stock markets had already naturally bounced 15.0% higher, the Fed formally announced what is now known as QE1. It brazenly told the world it was going to monetize debt to flood the economy with new money and drive down interest rates.

In that fateful day’s FOMC statement, Bernanke and his merry band of market manipulators said they were going to conjure up another $1150b out of thin air to buy various securities! This broke down as $750b more of mortgage-backed securities, $100b more of agency debt, and for the first time ever $300b in “longer-term Treasury securities”. It gave a timeframe of 6 months to complete these Treasury purchases. This announcement pushed QE1 up to its staggering total of $1750b (nearly trillions)!

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