It’s widely agreed that QE has helped to reduce bond yields. Academic studies suggest that each $100bn of QE has reduced 10-year US government bond yields by between 0.03 and 0.15 percentage points, and has also raised share prices because some of the money investors have raised from selling bonds to the Fed has been invested in equities.
But the Fed's announcement next week is not expected to seriously hurt markets. One reason for this is that it is widely expected and so should be embodied in prices now. Also, the move would mean only that monetary policy is loosening at a slower pace than recently; it doesn’t represent a tightening of policy.
What's more, economists expect Fed chairman Ben Bernanke to try and calm the markets. They expect him to reiterate that he'll continue QE until the labour market "has improved substantially", and that he won't raise interest rates until unemployment has fallen to at least 6.5 per cent: it is currently 7.3 per cent. "The fed funds rate is not going to be raised for a long time" says Chris Iggo of Axa Investment Managers.
A bigger worry is that the same economic recovery that causes the Fed to gradually withdraw QE will raise bond yields around the world. Economists have a rule of thumb that yields should usually be around the same rate as annual nominal GDP growth - which should imply 10-year US Treasury yields of 4-5 per cent, rather than their current 3 per cent. "Ten-year Treasuries are still expensive - as are gilts," says Kevin Gardiner at Barclays. "Much higher yields will come," agrees Mr Iggo.
But this need not be so worrying for shares. While less loose monetary conditions are bad for equities, the same economic growth that causes the Fed to reduce QE is good for them. Although Mr Gardiner fears that emerging markets could suffer more as a normalisation of US monetary policy reduces western buying, he’s more sanguine about developed markets. These, he says, "look inexpensive."
