End of QE2 may be less painful than feared

BNPP_IP_LOGOThe shock to the stock market when the United States ends the second round of quantitative easing (QE2) in June may be less severe than many expect, according to William De Vijlder, CIO strategy and partners at BNP Paribas Investment Partners.

In a blog post called 'the end of free champagne needn't stop the party!', De Vijlder challenges some analysts' claims that the end of QE2 will cause depressed equity prices.

The argument goes that when the Federal Reserve ends its programme of buying US treasuries – its method of achieving quantitative easing – there will be an increase in bond yields. This will make bonds more attractive relative to equities, causing inflows into bonds and a drop in equity prices.

But De Vijlder claims the system of economic flows that underpins stock market movements need not be affected this way. The size of the government deficit, the rate of saving, foreign appetite for US treasuries and demand for corporate borrowing will all affect demand for bonds. He adds: “The main factor is also the least predictable: namely, investors’ risk appetite.”

De Vijlder concludes that it is “more important to assess how the end of QE2 will impact the stock markets and corporate bond spreads rather than government bond yields”. A loss of confidence in the economy would certainly trigger a flight to the safety of US treasuries, and so depress equities. But this is only one possible outcome of the end of QE2, and not a necessary consequence of the end of 'free champagne', claims De Vijlder.

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