EUR 125.40 For Business Accounts Only

Are you an equity investor? The Fed is your friend...

​There is an ongoing debate on the impact of monetary policy on financial asset and macroeconomic volatility, with a number of economists claiming that quantitative easing has induced lower volatility in financial markets, while others believe that low interest rate policy and quantitative easing has created asset price distortions that could eventually create higher volatility both in financial markets, as well as in the real economy.

U.S. quantitative easing was largely based on the so-called “portfolio substitution” strategy, i.e. the purchasing of large amounts of long duration bonds by the Federal Reserve to drive down long-term interest rates, in order to encourage investors to shift from bonds into stocks, increase share prices, raise household wealth, and, eventually, consumer spending. More specifically, the purchase of large quantities of long duration securities brought down risk premia and compressed or removed significant market volatility from equities and bonds, pushing prices and valuations higher.

But is this ‘influence’ on financial markets that stems from major central bank monetary policy confined to the last seven to eight years, or, has it been evolving for a protracted period of time?

The truth is that central banks have been actively ‘cultivating’ the ‘appropriate’ conditions for stable markets for more than forty years. In this short note we show that the FOMC meetings, no matter the direction of the Federal Funds rate decision, has affected equity market returns.