In my previous post I made the case that the Fed is not exacerbating the safe asset shortage problem. Rather, the Fed has actually prevented it from becoming far worse. Michael Darda, chief economist of MKM Partners, makes a great follow-up point in an email:
One thing that jumped into my mind when reading [your post] was the consistent tendency for the yields on safe assets to rise during “QE on” periods. We’ve now had three episodes of QE since 2009, and in each and every case, the 10-year yield has risen on net, only to fall when the Fed stopped too soon (after QE1 and QE2 came to a premature end, that is). This, I think, is a pretty airtight refutation that the Fed is somehow exacerbating the safe asset shortage; indeed, this alone suggests that QE is actually relieving it. And even with the recent pullback in rates, the 10-year yield is more than 100 bps above where it was before QE3 began (with the S&P 500 up 25% or so over the same timeframe). This, in my view, means it is working.
Ironically, one implication of this analysis is that the safe asset shortage problem exists, in part, because the Fed was not doing enough. Or at least, not doing it right. This a point I made in my last National Review article.