By contrast, recent QE policies have targeted the amount of bonds to be purchased.  Central banks have allowed financial markets to determine the level of interest rates consistent with the level of central bank buying.  Since economists disagree on how much QE bond purchases have reduced interest rates (big surprise), we cannot be sure how much interest rates will rise as the QE policies are reversed.

We will have to revisit our positive equity market outlook if President Trump or the ECB appoints ideological leadership advocating a more radical retreat from QE, or if bond markets react more violently than we expect to the changing supply and demand environment.  These uncertainties mean that we will need to remain faithful to our risk management strategies and be ready to alter our portfolio positioning as the policy direction and market reaction become clearer.

Footnotes:

  1. In September of 2017, the Bank of Japan (BOJ) adopted an explicit interest rate target for 10-year Japanese government bonds (JGBs), similar to the Federal Reserve’s QE strategies during the 1940s and 1950s. The interest rate target was set at 0.10% at a time when JGBs were trading at negative interest rates.  By setting its interest rate target above prevailing market levels, the BOJ was able to reduce its monthly bond purchases.  Further tapering of these purchases will presumably mean raising the BOJ interest rate target.
  2. “Central Bank Balance Sheets: Expansions and Reductions Since 1900” – Niall Ferguson, Andreas Schaab, Moritz Schulerick. Published May 24, 2015 by the Center for Economic Policy Research.

This article was written by Michael Jones, CFA, Chairman and Chief Investment Officer at RiverFront Investment Group, a participant in the ETF Strategist Channel.

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