The QE boom in stock markets

Quantitative easing (QE) has evolved from a tool that lowered long-term Treasury yields in 2008 into a mechanism that absorbs credit risk in 2020.

By the COVID-19 crisis, long-term risk-free rates were already near zero, leaving the Federal Reserve no choice but to purchase riskier assets, including corporate bonds and high-yield ETFs, to maintain monetary transmission.

This policy fueled stock market rallies and pushed investors into junk bonds, but it also shifted systemic credit risk onto the Fed’s balance sheet.

The QE Boom in Stock Markets

As Zoltan Pozsar (2011) observed, institutional cash pools such as non-financial corporations, pension funds, and asset managers cannot simply leave their funds in bank deposits. Deposit accounts are convenient for small savers and secure only up to the government insurance threshold—$250,000 in the United States via the FDIC. Above that limit, large pools of cash require safe, collateralized instruments like asset-backed securities (ABS).

However, even ABSs carry residual risk because collateral prices fluctuate. In a downturn, collateral may fail to fully cover the lent amount. To meet the insatiable demand for safety, financial engineers tranche securities: senior tranches absorb minimal losses, while junior tranches bear the first hit in exchange for higher yields (Gorton & Metrick, 2012). This system produces a small quantity of “safe” debt by shifting the default risk down the structure.

QE and the 2020 Constraint

Global demand for safe assets has exceeded supply for years, driving yields on U.S. Treasuries and German Bunds to historic lows (Caballero et al., 2017). By early 2020, 10-year U.S. Treasury yields fell below 1%, and many European sovereigns traded at negative yields (FRED, 2020).

In 2008–2009, QE was effective because the Federal Reserve could still push long-term Treasury yields toward zero, encouraging portfolio rebalancing and credit expansion. But by 2020, the U.S. had already reached the lower bound for long-term risk-free rates. There was no room left to stimulate the economy by simply buying Treasuries.

This forced the Fed to extend QE into riskier assets—including corporate bonds, municipal securities, and even high-yield exchange-traded funds (ETFs). The rationale was clear: only by reducing risk premiums on private credit could monetary policy maintain its transmission to spending. In effect, QE shifted from a safe-asset operation to a credit-risk operation, relying on the Treasury to partially guarantee corporate credit facilities (Board of Governors, 2020).

QE as a Stock Market Engine

As safe assets were absorbed by QE, investors were pushed into riskier assets, including junk bonds and equities. This dynamic fueled stock market rallies despite the real economy’s weakness.

• After QE1 in 2009, the S&P 500 gained over 70% from its trough (Federal Reserve, 2010).

• In 2020, stocks rebounded from their fastest collapse in history before GDP recovered, as the Fed guaranteed corporate credit markets (IMF, 2021).

Institutional investors are fully aware that they are sitting on unprecedented credit risk. Non-financial corporate debt reached 50% of U.S. GDP by 2020, exceeding pre-2008 levels (BIS, 2020). This reflects a liquidity-fueled bubble that depends on the expectation of continued Fed intervention.

Systemic Risk and the Fed’s Exposure

Each QE round transfers credit risk to the public sector. While 2008-era QE mostly involved Treasuries and agency MBS, 2020 QE created contingent taxpayer exposure to corporate defaults. Treasury-authorized backstops were required to compensate the Fed for potential losses on riskier securities.

The addictive nature of QE is evident: each new crisis has required larger, riskier interventions. If a new economic shock arrives when the Fed cannot expand its balance sheet further—whether due to inflation, political constraints, or insufficient Treasury guarantees—markets may face severe turmoil as the QE-dependent safety net fails.

Conclusion

The 2020 QE cycle marked a structural shift: with long-term risk-free rates already at zero, the Fed had no choice but to buy riskier assets to maintain monetary transmission. This strategy has inflated stock markets and risk assets, but it also increased systemic fragility by embedding credit risk in the Fed’s balance sheet. Unless new policy frameworks—such as macroprudential tools or central bank digital solutions—address the safe asset shortage, QE may become an ever-riskier, less sustainable pillar of financial stability.

References

• Board of Governors of the Federal Reserve System. (2020). Federal Reserve takes additional actions to provide up to $2.3 trillion in loans to support the economy.

• Caballero, R. J., Farhi, E., & Gourinchas, P. O. (2017). The Safe Assets Shortage Conundrum. Journal of Economic Perspectives, 31(3), 29–46.

• Federal Reserve Bank of St. Louis (FRED). (2020). 10-Year Treasury Constant Maturity Rate.

• Gorton, G., & Metrick, A. (2012). Securitized Banking and the Run on Repo. Journal of Financial Economics, 104(3), 425–451.

• International Monetary Fund (IMF). (2021). Global Financial Stability Report: Preempting a Legacy of Vulnerabilities.

• Pozsar, Z. (2011). Institutional Cash Pools and the Triffin Dilemma of the U.S. Banking System. IMF Working Paper.

• Bank for International Settlements (BIS). (2020). Credit-to-GDP Gaps and Non-Financial Corporate Debt Data.my recovers in the near term, such a downfall is inevitable both in stock and bond markets.