How does QE Affect the Markets?

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Indexes
  1. Risk-On
  2. Risk-Off

*If you need a quick refresher on what QE is, check out yesterday’s write-up.*

Money swirling around the economy (liquidity) needs a home. Depending on different economic climates and monetary policies, investors as a whole have different risk appetites.

As mentioned, a big factor for investor psychology is the actions of The Fed, what their policies are, and whether or not their actions should result in a bull or bear market.

The markets cling to every word of The Fed, checking for positive or negative undertones in their verbiage. Even the slightest indication of dropping interest rates can result in a market frenzy, as it could signal a Fed who wants increased economic activity and therefore a healthy stock market.

*Side Notes: You might have heard the terms “Hawkish” and “Dovish” when referring to the Fed’s policy stance:

  • Hawkish🦅 = higher interest rates⬆️ = more difficult money = lower inflation.
  • Dovish🕊 = lower interest rates⬇️ = easier money = higher inflation.*

Risk-On

When the market sentiment is optimistic, higher-yielding assets get more expensive as money is more confident due to market and policy conditions and seek higher returns.

Investors park money in riskier assets like stocks, crypto, commodities which have more upside.

Generally if stock market is going up = risk-on environment.

This type of environment is great for big returns and easy gains but like anything, what goes up must come down. Heavy risk-on sentiment can lead to asset bubbles forming if too much money chases an asset and pushes the price far past what fundamentals can justify.

Risk-Off

When you get uncertain market conditions like we have currently, money is scared so gets parked in much safer but also lower-yielding assets.

Money flows into low risk assets like government bonds or safe currencies (savings accounts) or, if left in the stock market, safer equities that are seen more as essentials like energy, consumer staples, utilities.

Stock market going down = risk-off environment.

Naturally, a collapsing asset opens the doors for short-sellers to ride markets down, further crushing prices. We’ve seen basically all markets battered in the last few months as money has moved from a long risk-on mentality to now a risk-off mentality.

A result of this has been the US Dollar Wrecking Ball that’s gained significantly in value over the past few months to the point where at time of writing $1USD = €1EUR.