Counterproductive QE
Following the Warsh Fed Chairman nomination, we review the malinvestment implications of large-scale asset purchases in the early '10s and '20s, as well as lingering effects.
For a detailed discussion of the Warsh nomination for Fed Chairman here is a podcast we recorded this week:
Toward a New World Order: The K-Shaped Economy Amidst a Warsh Federal Reserve
In this week’s note:
Duration tightening as the catalyst: The Fed’s decision to reinvest MBS paydowns into Treasury bills (not coupons) marks a deliberate shortening of SOMA duration, tightening financial conditions and helping trigger a recent, modest risk-off move across equities, credit, crypto, and commodities—especially in richly valued, long-duration assets.
Risk-off tremor, not a crash: The ~3% S&P 500 pullback resembles past episodes like early-2018 “Volmageddon,” where modest tightening exposed crowded and speculative positions; valuations remain historically rich, making markets vulnerable to further shocks, but the move so far is not seen as a compelling entry point.
QE’s legacy: misallocation of capital: The note argues that successive QE programs suppressed volatility and distorted duration, leading to malinvestment, weak productivity, subdued capex, and a K-shaped economy—benefiting financial assets and housing over cyclicals, labor dynamism, and broad-based growth.
Banks and credit still constrained: Despite 175bp of rate cuts, restrictive regulation and an only partially normalized yield curve continue to clog the small-bank credit channel; regulatory relief plus further curve steepening are seen as essential to restoring credit creation.
Outlook: more cuts, periodic tremors: Softer labor and inflation data could pull forward additional rate cuts in 2026, and balance-sheet duration reduction will take time. The sequencing of rate cuts, banking regulatory relief, followed by additional DT is likely to preclude a disorderly adjustment. Even so, in the coming months long-duration assets face ongoing financial conditions tightening risk, consequently, periodic risk-off episodes, and our base-case ~10% equity drawdown—are our justification for a cautious stance with elevated cash.