What are central bank asset purchases?

July 2024 by Ana Carrisso

We didn't know it at the time, but in 2008 the then chairman of the Federal Reserve, Ben Bernanke, began the biggest monetary experiment of this century under the acronym QE (quantitative easing). The US monetary authority launched its first asset purchase program, an extraordinary measure for equally extraordinary times. 

The first QE was a program of monthly purchases of MBS (mortgage backed securities) and debt guaranteed by government agencies, which came about after the Fed had unsuccessfully reduced interest rates to the emergency level of 0.25%. The logic behind the purchases of financial assets is that the central bank, acting as a strong buyer, would increase demand, causing the price of bonds to rise and, consequently, interest rates to fall. This fall in bond yields would be reflected in the financing costs of bank loans, and would have an impact on the real economy as a boost to consumption and investment, stimulating a rise in inflation.

Although Bernanke was harshly criticized for his heterodoxy, QE became a shock tool that the Fed used again between November 2010 and June 2011 (QE2) and between September 2012 and October 2014 (QE3), extending it to the purchase of US Treasury bonds. In addition, Bernanke got the markets moving with Operation Twist between 2011 and 2012 (Maturity Extension Program or MEP, a program consisting of the sale of short-duration Treasury debt and the purchase of long-duration bonds) and initiated a policy of reinvestment at maturity of the assets on the Fed's balance sheet. 

Asset purchases in Europe

In 2012, Mario Draghi stirred up the markets with his famous "Whatever it takes". He became the man who saved the euro with his brilliant idea, the OMT (Outright Monetary Transactions) mechanism, which allowed the ECB to buy debt issued by eurozone countries on the secondary market and which was never implemented. The ECB has implemented other programs, such as TLTRO (Targeted Longer-Term Refinancing Operations), a mechanism designed to stimulate the eurozone economy through the credit channel, facilitating financing for banks at very favorable costs, on the condition that they can transfer this money to companies and consumers through loans. 

Those were the "lower for longer" years, when rates fell to negative levels, leading investors to literally pay the issuer to hold their debt. The effect couldn't have been more pernicious for investors, encouraging them to seek returns on increasingly risky assets.

The impact of the pandemic

Janet Yellen's arrival at the Fed meant a very gradual withdrawal of quantitative stimuli and the normalization of interest rates. But in 2020, the institution, in the hands of Jerome Powell, was forced to launch QR4 to deal with the pandemic. The ECB launched the PEPP (Pandemic Emergency Purchase Programme), its own version of QE, a public and private asset purchase program that lasted from 2020 to 2022. 

The rapid escalation of inflation in 2021-2022 has brought the main economies to the other side: from QE to QT or quantitative tightening, with the most aggressive cycle of rate hikes in four decades. "Higher for longer" now prevails, a context of higher interest rates for longer, with inflation stubbornly resisting the central banks' target and consumption holding up against all odds. As professional investors, we recognize the positive aspects of the return of inflation to a growing world. As asset managers, we welcome the divergences that have returned to the market, using the volatility that central banks are causing to our advantage. 

Frank Herbert wrote in Dune: “The highest function of ecology is the understanding of consequences.” Something similar holds with economics. Although imperfect, it is a science that allows us to understand the actions of monetary institutions in order to anticipate their consequences for the market. At Fidelity, we are waiting for the central banks to write the next chapter of their monetary policies, whether with new acronyms or others we already know.