Quantitative easing and share prices

Andrew Smithers in the Financial Times:

QE consists of the US Federal Reserve buying assets, which expands the monetary base. The chart shows that the expansion of the Fed’s balance sheet has moved with the US stock market. This is not just an accident. When the Fed buys assets the sellers have money and, unless they wish to increase their cash holdings, they will attempt to spend the money on other assets. Unless there is a rise in liquidity preference, which is when investors want to hold more cash, this will push up asset prices.

I pointed out in blog two that households have been persistent sellers of shares, but their selling pressure has probably been eased in recent years by the Fed buying assets. Equally, companies have been major buyers and have issued a lot of debt to help finance these purchases and, as the Fed have been buying other forms of debt, the sellers have been eager buyers of company debt.

This provides a good explanation of how QE has pushed up the stock market. Now QE is being reduce it is likely that the push will become less strong, but I think it will continue to be a help for some months. QE is not ending, it is just slowing. There will be less support for the stock market but the monetary base will continue to rise, even if a bit more slowly, and if the pattern shown in the chart continues, then this will also be true of the stock market.