QE and the term structure of rates

Background information first, answer later-

The Fed sets the fed funds target at their regular meetings, and lets the market then determine the term structure of rates.

That term structure of rates is therefore largely a function of anticipated future fed funds rate settings.

Then the Fed does QE- buys longer term securities at market prices- to try to bring longer term rates down, particularly mortgage rates.

But longer term rates don’t come down as much as hoped for.

Now to the point all this:

What the market place believes QE does, and not what QE actually does, is the same ‘force’ that largely determines the term structure of rates.

And so when the Fed does QE,
and the market place believes that QE will work to promote a strong economy and risk inflation,
the term structure of rates goes up in anticipation of higher fed funds rate settings by the Fed down the road.

And when the Fed ends QE,
that same market place then believes that support has been pulled from the economy,
the future is no longer as inflationary,
and the term structure of rates falls as fears of future fed funds hikes subside.

It doesn’t matter that the mainstream beliefs are wrong with regard to QE,
because the term structure of rates only reflects those same mainstream market place expectations, regardless of their actual validity.

And yes, this all highly problematic for a Fed trying to keep long rates down.

75 replies on “QE and the term structure of rates”