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11 13 2015 | by Victor Xing | Capital Markets

Is quantitative easing reversible?

Yes indeed, effects of quantitative easing can be reversed.  The reversal process is relatively easy to implement (by selling assets held on FED’s balance sheet, which were accumulated during QE programs), but it is generally considered a “last resort” due to severe financial market impacts.

Asset sales can directly affect part of the yield curve that is closely correlated with consumer lending – 5 to 10 year in maturity, and investors will not only price-in what the central bank will be selling, but also the pace which they will be selling in the future, not to mention how these sales will force other asset managers to sell their bonds to avoid losses.

Moreover, potential asset sales will likely take place under period of high realized inflation, making it likely that the central bank may sell assets AND raise short-term interest rates (thus push up the yield curve in parallel – there is no place for fixed income investors to escape).

Thus, mere hints of asset sales can easily result in a stampede that would rapidly raise borrowing cost and tighten financial conditions.  Nevertheless, the process of reversing quantitative easing is mechanically simple to accomplish.

Quantitative easing and the FED's balance sheet
FED’s balance sheet – potential source of asset sale

Next article11 13 2015 | by Victor Xing | Central Banks

What is the New York Fed Markets Group?