---
title: "What Did Quantitative Easing Do to the Stock Market?"
description: "What is quantitative easing? Why did the Federal Reserve buy bonds? What did the Fed's QE bond buying program do for the stock market?"
canonical_url: https://trendshare.org/how-to-invest/what-did-quantitative-easing-do-to-the-stock-market
markdown_url: https://trendshare.org/ai/what-did-quantitative-easing-do-to-the-stock-market.md
published: 2014-01-31
last_updated: 2017-08-28
content_license: https://trendshare.org/about/disclaimer
---
# What Did Quantitative Easing Do to the Stock Market?

Source: https://trendshare.org/how-to-invest/what-did-quantitative-easing-do-to-the-stock-market
Updated: 2017-08-28
You may have heard it said that "The economy is one big market." Think of a
classic bazaar with a huge mass of people walking slowly past countless stalls
of vendors hawking everything from rugs to jugs to fruit and vegetables. People
are buying and selling and haggling and negotiating. Through it all, money and
goods are trading hands.

Now imagine that all the buyers suddenly stop. Every vendor wants to sell
his or her wares, but no money is trading hands anymore. In short order, people
wander away. Vendors pack up and leave. Soon, the whole place is a ghost
town.

You've just imagined something like the global recession of 2008. In a
recession, people don't spend money—whether they don't *want* to
or they can't. Everything slows down. In the *technical* explanation of
a recession is a drop in GDP for two quarters in a row, but we can afford not
to be economists here for a moment.

## What Does the Federal Reserve Do?

In the United States, [the Federal Reserve controls the amount of currency in circulation](https://outspeaking.com/words-of-politics/what-is-currency-and-fiat-currency.html). It works
with the largest banks in the economy to add money in circulation (so there's
more to spend: to stimulate a sluggish bazaar) or to remove money from
circulation (so there's less to spend: to slow down an overheated bazaar).
Their goal is to regulate capitalism and make it a little more predictable.
The intent is to reduce the frequency and risk of bubbles and reduce the
magnitude and length of recessions.

(The next interesting question is "How does the Fed make money?" Its goal
isn't to make money, so it doesn't matter—but it does make money when it
buys low and sells high and makes money on interest payments from the bonds it
owns. Capitalism still works even with a fiat currency.)

## What is Monetary Policy?

This *monetary policy* is controlling the amount of money in
circulation. The Fed primarily does this by setting the interest rate it
charges when it lends money to banks. (See [Why does the Federal Reserve lend money to banks?](https://www.federalreserve.gov/faqs/banking_12841.htm)) The lower the interest rate, the
cheaper it is to borrow money and the more attractive it is to spend that
money. The bazaar heats up. The higher the interest rate, the more expensive it
is to borrow money and the more attractive it is to save that money. The bazaar
cools down.

## Quantitative Easing Defined

If you think about it for a moment, you'll realize that the Fed can only
reduce interest rates so far. If the bazaar is too quiet and the interest rate
the Fed charges is zero percent, what then? How can the Fed encourage people to
spend money rather than save it?

Maybe you've heard of "QE". QE stands for *Quantitative Easing*.
That's a mouthful, but it's a technical term which describes what you already
understand from this article.

Quantitative easing is the program under which the Federal Reserve began to
spend money buying short-term bonds from banks. In other words, it began to
*purchase* from banks rather than letting banks borrow money.  Where did
QE money go? To the banks!

Basic economics has established that when there are more buyers than
sellers, the price goes up. Because there's more competition to buy these bank
bonds (a new buyer is in town with lots of money to spend), the interest rates
of those bonds go down (as sellers don't have to compete to make those bonds
attractive; if there weren't many buyers, a seller would raise the interest
rate offered to attract buyers). Quantitative easing lowers interest rates by
increasing the number of buyer dollars!

Buying short term debt from a bank gives that bank money to lend out right
away. In theory, this makes loans more likely to occur and increases the amount
of money in circulation. In theory, this gives the bazaar a little jolt of
energy, like a caffeine injection.

Yet that's only part of the story.

## What Does Bond Buying Do to the Stock Market?

Where do you invest your money and why? You probably have a mixture of [risk tolerance](https://trendshare.org/how-to-invest/understanding-investment-risk) and the desire for a
good return. [Buying a US government bond](https://www.savingsbonds.gov/) or a bank bond is safe, but you won't get much return. When the Fed
has an effective zero percent interest rate *and* where the *Federal
Reserve bond buying program* (that's *quantitative easing* again),
the interest rate paid by bonds will be very low. In fact, if there's any
inflation at all, you'll lose money by investing in these short-term bonds.

That money has to go somewhere.

The Fed hopes some of it will get spent. The Fed wants it to circulate
through the economy. Ideally a lot of it will go to things like small business
loans and cheaper mortgages. A lot of those investment dollars went into the
stock market.

It's no surprise that the [S&P 500 Index](https://trendshare.org/how-to-invest/buy-the-s&p-index-fund) had around 30% returns in 2013 and, [with dividends reinvested, a 14% return in 2014](https://seekingalpha.com/article/2791755-2014-s-and-p-500-return). People wanted to buy stocks
because they thought they'd get a better return than from investing in bonds.
This isn't a surprise. When bond interest rates go down, stock prices tend to
go up.

You have that right—the Federal Reserve buys and sell bonds through
their Quantitative Easing program in order to affect interest rates for large
financial institutions and the entire US economy.

## Quantitative Easing and the Stock Market

Quantitative easing's effect on the stock market is easy to predict: prices
will go up when it's in effect and down when it's not. People see that 30%
improvement in the market and want to take a nice profit. Sellers outnumber
buyers and prices go down.

Keep in mind that results from the Federal Reserve's bond buying and selling
programs are temporary. [Good stocks](https://trendshare.org/how-to-invest/how-to-pick-good-stocks) are
always worth investing in, and in any economic condition you can find good
stocks worth owning—if you're willing to look. Will money market rates go
up? Eventually. Gradually.  When and how depends on inflation.

In practice, there'll be fewer buyers than sellers, so bond prices should go
down and interest rates will go up. In theory, that means less money going into
stocks, so the market will likely reflect that: because buyers *believe*
that there will be fewer buyers, they'll invest less, making a vicious
cycle.

The good news for value investors is that this may expose more bargain
stocks. (Does this mean that there are suddenly a lot of good banks to invest
in? Doubtful; tighter lending standards, even informally and internal to banks,
mean there's less appetite for risk in banks.)

The [Federal Reserve's QE rounds for the 2008 financial crisis ended in late October 2014](https://www.nytimes.com/2014/10/30/business/federal-reserve-janet-yellen-qe-announcement.html). Things have largely gone back to normal since then, though some
investors argue that the stock market is still inflated and overheated in
comparison to economic performance and historical stock market returns.

As always, [the market's daily or weekly or monthly fluctuations aren't as important as buying great stocks and holding them for the long term](https://trendshare.org/how-to-invest/what-happened-in-the-stock-market-today). You can make a good return in
the stock market regardless of quantitative easing or recessions if you're
patient and thoughtful.