The investment banking world seems to be quite concerned about the so-called “end of QE3.”

End of QE3 a Top Concern and Well-Grounded in Experience

Indeed, in discussions about global economic conditions, current top concerns seem to put the end of QE3 just as high in importance as slower, but still robust, growth out of China or a potential recession in Europe (some analysts perhaps even have the end of QE3 as higher than China or Europe concerns).

The investment bankers’ concerns about what the end of QE3 might mean for the market are well grounded in recent equity market performance. The figure below depicts the performance of the S&P 500 and the expansion of the Federal Reserve core balance sheet. Three points are important. The end of QE1. The end of QE2. And the end of QE3. If one follows these points upwards to the performance of the S&P 500 (top graph), it clearly shows a connection.

1 QE jsd.fw

History of Quantitative Easing

Now some background. QE1 ended in June 2010. In anticipation of the end of QE1, the market responded, with the S&P 500 declining around 15% from peak to trough (April to mid-August).

The response of the market and concerns about the strength of the economy led the Fed to announce $30 billion in Treasury securities, keeping the Fed’s balance sheet at $2.05 trillion (absent this move, the Fed’s balance sheet would have naturally declined as bonds are paid off).

In Bernanke and Fed officials’ views, the economy was still on shaky ground. Only five months after officially ending QE1, the Fed announced QE2, a $600 billion bond-buying program. QE2 didn’t last too long, ending in July 2011. Akin to the end of QE1, the market was displeased with the Fed’s actions, with the S&P 500 dropping about 15% from peak to trough.

About a year after the end of QE2, the Fed was concerned of continued slack in economic activity. The Fed’s response, unsurprisingly, was QE3. On September 13, 2012, on an 11-1 vote, the Fed announced QE3, initially set at $40 billion per month. The $40 billion per month wasn’t high enough in the Fed’s view, pushing the bond-buying program to $85 billion per month soon after the start of QE3.

About 9 months after the announcement of QE3, the Fed began tapering policy, initially dropping the bond purchase program from $85 billion to $65 billion.

Market Starts to Think About the End of QE3

With the Fed now close to ending QE3, it’s completely unsurprising to see the market start to react. Since September 18th, the S&P 500 is down about 4% as of writing. This decline leads one to wonder: which will come first – a Federal funds rate hike or QE4? With the history of quantitative easing as background, would you guess a rate hike or QE4 would come first?

Presuming QE3 ends in November/December, and the Fed’s current path of increasing the federal funds rate in June 2015, the Fed has to make it 7 to 8 months of no quantitative easing before it raises rates. Will the Fed make it to June 2015 without further balance sheet expansion?

If the previous four years is the guide, the answer is no. The market doesn’t want QE to end and the Fed is generally a market pleasing institution. Will it oblige to market opinion? Probably yes.

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Generally, investment bankers have been pleased with central bank policy over the past five years. So why are investment bankers happy with central banks?  There are two main reasons.

First, investment banks benefit from the increased risk taking, trading activity, and deal volume that lower interest rates encourage. Second, keeping interest rates low reduces any interest costs on investment banks’ balance sheets. With these two reasons in mind, it is completely unsurprising that investment bankers are nervous about impending rate hikes in the U.S.

Central Bankers’ Loosening Cycles

As of writing, observers of Federal Reserve policy place the end of the current loosening cycle (a time when the Fed is not increasing interest rates) somewhere around June 2015.  (The June 2015 is squishy; even voting members of the FOMC disagree strongly on when rate hikes will take place.) Presuming the Federal Reserve actually raises rates early next summer, it would mark the end of the current loosening cycle that began September 18, 2007.

A loosening cycle of eight years is quite long.  What makes the current Fed loosening cycle so interesting is that Yellen and company have not only kept rates low for so long, but that they have kept rates so low.  In addition to being the longest loosening cycle ever, the Fed has interest rates at the lowest levels in history.

Investment bankers, of course, cheer such policy on.  However, are investment bankers really happy with how much savings is missing in the world because of historically low central banks’ policy rates?

A Look at the Numbers

The first graphic shown contains a history of what central bankers across the globe have done with their main policy rate since 1990. Overall, rates have been on a long-term trend downward for some time. The chart also shows that central banks generally think alike, with very little competition for business.

1 Central Bank Policy Rates

Moving on to the topic of interest – savings. When investment bankers encourage the Federal Reserve and other central banks to keep interest rates low, they are adversely affecting some individuals. Chief among those adversely affected are savers, a large portion of whom are young workers and elderly or soon to be elderly Americans.

By how much have central bankers adversely affected savers? The following two graphics have the answer. (A note on the numbers: interest income statistics by country comprises a number of estimating procedures; the following numbers are best interpreted as rough estimates.)

The first graphic puts the missing interest income at about $1.6 trillion in 2014, or about 2% of global GDP. The second graphic looks at the missing interest income on a cumulative basis.  The cumulative missing interest income (savings) is around $7 trillion (2009 to 2014). The places where savers have been hurt the most are in Europe ($1.5 trillion), the U.S. ($1.4 trillion), and China ($800 billion).

2 Missing Interest Income

3 Cumulative Missing Interest Income

Is the Missing $7 Trillion Worth It?

How can investment and central bankers argue that the global economy is better off without the $7 trillion? The answer is that investment bankers and like-minded individuals think the global economy has been boosted by at least $7 trillion. Is there evidence that the global economy has been boosted by $7 trillion? The honest answer is – no.  There is literally no evidence.  In fact, if one simply takes correlation as evidence, the current economic situation is much worse than historical recoveries would have predicted.

Therefore, whether hurting savers has helped the global economy comes down to presumptions, not evidence.

The Question at Hand

Getting back to the question posed originally – are investment bankers happy with how much savings is missing in the world? The answer is probably yes.  Investment bankers, as a group, see the missing $7 trillion as more of a “thank goodness that cost is not there” situation. Whether they are right that hurting savers by $7 trillion is worth any potential benefit depends entirely on your assumption about the state of the global economy.  It has nothing to do with evidence.

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In the financial world everything is competitive.  Going along with the culture, of the three major sectors – investment banking, private equity, and hedge funds – where has employment expanded the fastest?  Here’s a look at employment growth by these three sectors since 2008.

Total Employment Growth Since 2008

In total growth terms, private equity has experienced the strongest recovery, up 4.3 percent since January 2008. In second place is hedge fund employment, up 3.3 percent. Coming in last is the investment banking sector, still down 4.7 percent.

1 Growth in emp

Employment Growth by Month

The total growth outcome leaves some questions.  The following is a look at employment growth since 2008 by these three sectors broken down by month.  Some interesting trends emerge.

First, the recovery has not been smooth for any of the three sectors, although private equity comes somewhat close.  The investment banking sector has gone through the choppiest recovery when measured by magnitude and frequency of declines.  The sector reached a low of -9 percent growth in both January 2011 and May 2012.  The best growth figure the sector has had since 2009 (relative to 2008) was in August 2010, where it was almost flat, to where employment stood in January 2008. The smoothest recovery has occurred in private equity.  The sector bottomed out at about -4.6 percent in May 2010.  The sector’s recovery has been relatively non-choppy, with consistent gains since May 2010 (with the occasional hiccup).

Second, the timing of the recession’s effect was somewhat different for all three sectors. The investment banking sector peaked in August 2008 at 2 percent. In contrast, hedge fund employment peaked in October 2008 at 8 percent followed by private equity employment, which peaked in December 2008 at 2 percent.

The bottoms did not coincide either, with investment banking bottoming out in September 2009 at -8 percent (at least for the initial bottom), hedge fund employment in November 2009 at -13 percent, and private equity employment reaching the bottom around May 2010 at about -5 percent.

Finally, investment banking employment growth continues to lag, while hedge funds and private equity are taking off.

2 total emp change since 2008

The Investment Banking Sector’s Trouble

What’s behind the weakness in the investment banking industry? One main force appears to be most influential in the investment banking industry’s troubles.

The detrimental factor is the passage and implementation of Dodd-Frank in July 2010.  Interestingly, employment in the investment banking industry shows as clearly being adversely affected by Dodd-Frank.  In fact, employment in the investment banking industry was just about positive in July 2010.  Following passage, employment in the industry went south quickly.


Overall, private equity is in first place for employment growth (up 4.3 percent) among the three large investment industry sectors.  In second place is hedge fund employment (up 3.3 percent).  Last place belongs to the investment banking industry, still down 4.7 percent from where it was in January 2008.  Only time will tell if the investment banking industry will ever catch up with its finance industry cousins.

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