In addition to yesterday’s post on interest rates, the chart below is another puzzling dynamic of QE. The ECB’s balance sheet has shrunk by almost 1/3 in the last year, yet European equities have risen by nearly 40% over the same time frame. Considering that balance sheet expansion is assumed to boost securities prices, one would expect balance sheet contraction to have the opposite effect.
Based on this data, one could take the view that the impact of balance sheet expansion is mostly exaggerated (the San Francisco Fed apparently seems to agree). However if you do subscribe to this view then don’t you kind of have to have an explanation as to why we’re even doing QE then? Has QE simply been a giant red herring?
No matter what you think, the case below should at least be one encouraging data point demonstrating that bad things don’t necessarily have to happen when the Fed eventually tapers.