Worries about potential side-effects of unconventional monetary policy on financial markets are at least exaggerated, if not a near figment of the imagination.
This appears to be the conclusion of a comprehensively-argued research note by Bank of America Merrill Lynch global economist Ethan Harris.
The risk investors need to focus on is disinflation, not inflation; yet, remarkably, over the last several years critics of the Federal Reserve’s quantitative easing have “hijacked” the inflation debate, Harris says.
Every time the Fed announces a new QE program or inflation ticks up a bit, critics warn of a potential surge of inflation. Sure enough, the QE3 announcement in September caused a knee-jerk jump in inflation breakevens, warnings of surging commodity prices and eventual broad-based inflation. All of this has the Fed on the defensive: their directive talks about what they will do if inflation is too high, but is mute on what they will do if inflation is too low.
Despite dire inflation warnings, Harris says the risk of unwanted disinflation is greater than that of unwanted inflation, reason enough “to fade the bond market sell-off.” Treasury yields surged in January after a last-minute agreement to avoid the “fiscal cliff” encouraged risk taking and reduced demand for safe-haven U.S. bonds, pushing yields higher.