Markets Have Posted Big Gains Since the Fed Launched QE2

Markets Have Posted Big Gains Since Fed Launched QE2
Markets Have Posted Big Gains Since Fed Launched QE2

Despite the concerns of Republican leaders about the Federal Reserve's second round of quantitative easing, stock and credit markets seem to approve of the so-called QE2: They've improved significantly since the plan was announced, Bloomberg reported Friday. But can that rally be solely attributed to QE2?

Conservatives say they fear the effect that QE2 could have on the strength of the dollar and suggest it could fuel long-term inflation and asset bubbles. Monetary policymakers, though, are more concerned about the dangers deflation and its effect on borrowing costs, and they have acted accordingly.

Fed Chairman Ben Bernanke first indicated on Aug. 27 that the central bank might buy more government securities to boost the U.S. economy. On Nov. 3, one day after the midterm elections, the Fed announced a plan to buy as much as $600 billion worth of Treasury bonds through June.

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Since Aug. 27, the Standard & Poor's 500 stock index has climbed 17%. Junk bonds also rallied, with the spread over government debt shrinking. Spreads on investment-grade corporate bonds also narrowed. Also, while the dollar is down 3.5% since Aug. 27, it has gained about 1.2% since QE2 began. And inflation has remained tame, according to the recent consumer price index report.

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The one major criticism of QE2 is that it hasn't actually worked. In fact, Treasury bond yields have jumped as their prices tumbled. The yield on the benchmark 10-year Treasury note has climbed to 3.42% from 2.64% on Aug. 27, according to Bloomberg.

Another big thorny issue is the high unemployment rate, which rose from 9.6% to 9.8% in November. The pace of economic growth is "insufficient to bring down unemployment," the Federal Open Market Committee said this week.

However, recent economic reports on retail sales, industrial production and consumer confidence signal the recovery is gaining strength. In addition, economists have been boosting their estimates for growth next year to include the stimulus effect of President Obama's tax cut compromise deal, which passed the House at midnight Thursday.

Some say it's these positive signs, as well as the European sovereign debt crisis, that have been mostly driving U.S. stocks higher. Whatever the real reason, the recent market rally is a welcome development.