Mckinsey lays out tapering blowback

McKinsey Global Institute has produced an in-depth document that states the obvious on the affects of QE and the likely problems with its withdrawal.

ƒBetween 2007 and 2012, ultra-low interest rates produced large distributional effects on different sectors in advanced economies through changes in interest income and interest expense. By the end of 2012, governments in the United States, the United Kingdom, and the Eurozone had collectively benefited by $1.6 trillion, through both reduced debt service costs and increased profits remitted from central banks. Meanwhile, households in these countries together lost $630 billion in net interest income, with variations in the impact among demographic groups. Younger households that are net borrowers have benefited, while older households with significant interest bearing assets have lost income. Non-financial corporations across these countries benefited by $710 billion through lower debt service costs.


ƒThe era of ultra-low interest rates has eroded the profitability of banks in the Eurozone. Effective net interest margins for Eurozone banks have declined significantly, and their cumulative loss of net interest income totaled $230 billion between 2007 and 2012. In contrast, banks in the United States have experienced an increase in effective net interest margins as interest paid on deposits and other liabilities has declined more than interest received on loans and other assets. From 2007 to 2012, the net interest income of US banks increased cumulatively by $150 billion. Over this period, therefore, there has been a divergence in the competitive positions of US and European banks. The experience of UK banks falls between these two extremes.
Life insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates. Those insurers that offer customers guaranteed-rate products are finding that government bond yields are below the rates being paid to customers. If the low interest-rate environment were to continue for several more years, many of these insurers would find their survival threatened.
The impact of ultra-low rate monetary policies on financial asset prices is ambiguous. Bond prices rise as interest rates decline, and, between 2007 and 2012, the value of sovereign and corporate bonds in the United States, the United Kingdom, and the Eurozone increased by $16 trillion.


But we found little conclusive evidence that ultra-low interest rates have boosted equity markets. Although announcements about changes to ultra-low rate policies do spark short-term market movements in equity prices, these movements do not persist in the long term. Moreover, there is little evidence of a large-scale shift into equities as part of a search for yield. Price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages.


Ultra-low interest rates are likely to have bolstered house prices, although the impact in the United States has been dampened by structural factors in the market. At the end of 2012, house prices may have been as much as 15 percent higher in the United States and the United Kingdom than they otherwise would have been without ultra-low interest rates, as these rates reduce the cost of borrowing. We based this estimate on academic research using historical data that suggest how housing prices rise as interest rates decline. In the United Kingdom, it is plausible that this relationship holds today. However, in the United States, it is unclear whether the historical relationship between interest rates and housing prices holds today because of an oversupply of housing and tightened credit standards.
If one accepts that house prices and bond prices are higher today than they otherwise would have been as a result of ultra-low interest rates, the increase in household wealth and possible additional consumption it has enabled would far outweigh the income lost to households. However, while the net interest income effect is a tangible influence on household cash flows, additional consumption that comes from rising wealth is less certain, particularly since asset prices remain below their peak in most markets. It is also difficult today for households to borrow against the increase in wealth that came through rising asset prices.

We should point out that other factors are also at work here beyond just low interest rates.

Ultra-low interest rates appear to have prompted additional capital flows to emerging markets, particularly into their bond markets. Purchases of emerging-market bonds by foreign investors totaled just $92 billion in 2007 but had jumped to $264 billion by 2012. This may reflect a rebalancing of investor portfolios and a search for higher returns than were available from bonds in advanced economies, as well as the fact that overall macroeconomic conditions and credit risk in emerging economies have improved. In some developing economies, including Mexico and Turkey, the percentage increases in capital inflows into bonds have been even larger. Emerging markets that have a high share of foreign ownership of their bonds and large current account deficits will be most vulnerable to large capital outflows if and when monetary policies become less accommodating in advanced economies and interest rates start to rise.


All pretty obvious stuff for someone not living under a rock. Financial repression benefits speculators and governments. The hesitance on stock price isn’t necessary. Anyone watching QEs 1 through 3 knows that share price go up when the Fed prints. That valuation multiples haven’t broken from long term averages simply implies that without QE they’d be a lot lower in a low growth environment.

Anyways, as you’d expect, reversing QE will spike peripheral bond yields, spike equity market volatility and raise debt servicing costs for households as well as pressure house prices. Which is why it’s going to happen ultra-slowly.

If it goes on then it’s bubbles!


  1. interested party

    “The impact of ultra-low rate monetary policies on financial asset prices is ambiguous.”


    “the value of sovereign and corporate bonds in the United States, the United Kingdom, and the Eurozone increased by $16 trillion.”……more bloody debt!

    “households in these countries together lost $630 billion in net interest income”…..less bloody income!

    Where is the ambiguity in those facts….looks straight forward to me!

    • And these rises in “wealth” from house prices going up……

      Also bullshit….! Not wealth unless cashed up via major downsizing or move downmarket.

      • Spot on ip and Phil.
        HnH “All pretty obvious stuff for someone not living under a rock. Financial repression benefits speculators and governments” Exactly!

        It’s going to go on so ‘it’s bubbles’ on a scale we cannot at the moment imagine. This all cannot be unwound without total destruction. As a result of multi-decades of mis-pricing the distortions in our society are fundamental. They cannot be fixed by pulling a few monetary levers. So QE has simply multiplied and exaggerated those distortions. It now cannot be withdrawn other than nominally. It will all go on until it can’t. Bubble away.
        ” ALL Double, double toil and trouble; Fire burn, and cauldron bubble. ”

        “Fair is foul, and foul is fair:
        Hover through the fog and filthy air”

  2. “Price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages.”

    Except that the ‘E’ in P/E is all thanks to the ‘E’ in QE!

    Corporate profit margins are at an all time high thanks to QE – we are about as far from ‘long-term averages’ as you can get. And when corporate profit margins return to historical levels (as they always have in the past), look out below!

    • True drcole. An even bigger problem is WHERE the E is! The E is in the FIRE economy. It’s the corporate profits of the parasites that have been boosted far more than the corporate profits of ‘industry’.
      So the parasites grow bigger and stronger eating away the host at a faster and faster rate.
      You have to wonder what goes on that this is not comprehended. I guess it is what universities have been teaching as economics for 50 years. ‘We don’t need no secondary or primary industry. Services are the sign of a prosperous economy’
      I guess it is also a sign of the total corruption of the democratic/media/social process.
      It can’t be stopped.

  3. Forgive me if this has already been discussed on MB; it is a don’t-miss:

    “Confessions of a Quantitative Easer”


    Nov. 11, 2013

    “…..In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

    It wasn’t long before my old doubts resurfaced. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

    From the trenches, several other Fed managers also began voicing the concern that QE wasn’t working as planned. Our warnings fell on deaf ears. In the past, Fed leaders—even if they ultimately erred—would have worried obsessively about the costs versus the benefits of any major initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or the latest in-person feedback from Wall Street’s leading bankers and hedge-fund managers. Sorry, U.S. taxpayer.

    Trading for the first round of QE ended on March 31, 2010. The final results confirmed that, while there had been only trivial relief for Main Street, the U.S. central bank’s bond purchases had been an absolute coup for Wall Street. The banks hadn’t just benefited from the lower cost of making loans. They’d also enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed’s QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.

    You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2.

    That was when I realized the Fed had lost any remaining ability to think independently from Wall Street…..

    “……Even by the Fed’s sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed El Erian at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output). Both of those estimates indicate that QE isn’t really working.

    Unless you’re Wall Street. Having racked up hundreds of billions of dollars in opaque Fed subsidies, U.S. banks have seen their collective stock price triple since March 2009. The biggest ones have only become more of a cartel: 0.2% of them now control more than 70% of the U.S. bank assets.

    As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing much-needed life back into 401(k)s, but for how long? Experts like Larry Fink at the BlackRock investment firm are suggesting that conditions are again bubble-like……

    “……The implication is that the Fed is dutifully compensating for the rest of Washington’s dysfunction. But the Fed is at the center of that dysfunction. Case in point: It has allowed QE to become Wall Street’s new “too big to fail” policy.”

  4. 1. Near zero interest for over 5 years
    2. Inflation low (< 2% ), justification: there is low demand, excess capacity
    3. Stock market and House prices near peaks reached in 2007, when interest rate were around 5-7%

    Is there any economic theory as to, how all these will span out? Everything that I studied, says free money = inflation!

    How can free money be good?????

  5. The McKinsey report ignores three other relevant factors in share prices (based on my reading of John Hussman).
    1. Profit share is at all time highs.
    2. Sectoral share to corporates has also been at historical highs (compared to governments and households).
    3. Shiller’s CAPE is at historical highs.

    The other interesting thing is that the US has still not reinstated “mark to market” for US banks.

    Based on my experience in banking during 92-97 workout period, it all smells of bank rescue without transparent, direct, taxpayer funded bailout.

    • The all-time high “profit share” is Wall Street, not “main street”.

      This is where the problem really lies.

      The political representatives of “labour” have wasted most of their efforts for more than a century playing “get the employer”, when it is the rentiers in finance and property that are the major threat to them both.

      According to Dr David Evans of the “Science and Public Policy Institute”:

      “……..The profits made in the financial sector (in the USA) increased from 10% of all profits before 1971 to 45% in 2006. The finance industry only employs about five percent of workers, and produces no tangible goods and few essential services, yet it captured a huge share of profit during the financial bubble. That is rent-seeking on a monumental scale……”

      I believe this share will have grown since 2006. I haven’t found any good sources of reliable data.

      • +100…Thanks Phil that’s what I was trying to say above as I hadn’t got down to your comment!
        The stat of profits to wages is misleading due to the rising dominance of FIRE which employs so few to gain profit. (Note I am not saying it is an irrelevant number just that it is distorted)