A few years ago the Bank of England (BOE) used the chart below to explain the impact of money printing on the economy and financial markets. According to the BOE’s graph, there are two phases to quantitative easing, an impact phase and an adjustment phase.
During the impact phase, there is a party on Wall Street. Asset prices soar far above what the underlying fundamentals would seem to support. The bonuses pile up and the liquor flows freely. Then, during the adjustment phase, economic activity and inflation pick up, but asset prices take it in the neck (red line).
With the Federal Reserve winding down its quantitative easing campaign at the end of October, the U.S. economy is likely moving from the impact phase to the adjustment phase. If the BOE’s stylized depiction of QE is accurate, Wall Street may soon wakeup with a brutal hangover.
Jeremy Jones, CFA
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