Putnam Investments

Quantitative easing: A closer look

October 2014 marked the end of the Federal Reserve's asset-purchase program known as QE3. The Fed has used quantitative easing – or "QE" – to drive down interest rates and inject liquidity into the economy in pursuit of maximum employment and price stability. The policy has not been without risks, however. The prices of many security types in the Barclays Aggregate indexes have been propped up by Fed demand. Given that the central bank has purchased roughly half the Treasury bonds that have been issued over the past two years, the U.S. government will need to find buyers for new issues in place of the Fed. Domestic private-sector investors tend to be more sensitive to yields versus the Fed or foreign government buyers. As a result, Treasury yields may need to go higher to attract sufficient demand from private-sector investors.

Explore more QE1 QE2 Operation Twist QE3 Tapering Fed's bond portfolio

A series of bond purchase programs have expanded the Fed's balance sheet while holding down interest rates.

Since early December, the Federal Reserve has been injecting $85 billion per month of newly created money into the financial system, buying mortgage-backed securities and longer-term Treasuries. November 2008 - March 2010: $1.25 trillion of agency mortgage-backed securities (MBS), representing about 25% of the outstanding market. October 2010 - June 2011: $600 billion in U.S. Treasuries, adding to the approximately $300 billion already on the government's books. October 2011 - December 2012: This program was designed to push down longer-term interest rates by using the proceeds from the Fed's maturing holdings to purchase longer-dated date. September 2012 - present: Targeted purchases of agency MBS of up to $40 billion per month. January 2014 - present: The Fed began reducing the amount of bonds it buys each month, citing improvement in the outlook for the labor market. With over $4 trillion in bond assets, how the Fed decides to sell its holdings could have a major impact on bond prices and yields.

Sources: U.S. Department of the Treasury, Federal Reserve, as of 12/31/14. Past performance is not indicative of future results.

What are the risks?

As the Fed concluded its asset-purchasing, interest rates could begin to head higher and bond investors may experience losses on their investments. The Fed holds more than $4 trillion in bond assets on its balance sheet – a historically high level. How the Fed approaches selling its assets in the future has the potential to have a significant impact on interest rates and bond investors. If the Fed attempts to sell too much of its holdings too quickly, the excess supply could cause bond prices to drop quickly.