Economics
How Quantitative Easing Affects Long-Term Bond Yields
Quick fact
During the Fed's QE programs after 2008, the yield on 10-year Treasury notes fell by over a percentage point, significantly lowering mortgage rates.
Why this is interesting
When a central bank starts printing money to buy bonds, long-term interest rates often drop. How can simply buying bonds make borrowing cheaper for everyone?
Read the full explanation
Understanding How Quantitative Easing Affects Long-Term Bond Yields
Think of bonds as IOUs. When the central bank wants to stimulate the economy, it creates new money and uses it to buy long-term government bonds from banks and investors. This injection of demand pushes bond prices up. But bond prices and yields move in opposite directions: when a bond's price rises, its yield (the interest it effectively pays) falls. So by buying bonds, the central bank directly lowers long-term yields. Lower yields on government bonds spill over to other long-term rates like mortgages and corporate loans, making it cheaper for businesses to invest and for consumers to buy homes, which helps boost economic activity.
A deeper explanation
Quantitative easing operates through several channels, the most direct being the portfolio balance channel. By purchasing long-term bonds, the central bank removes them from the market, forcing investors to reinvest in riskier assets like stocks or corporate bonds, which pushes their prices up and yields down. Additionally, the central bank's commitment to keep buying signals that short-term policy rates will stay low for a long time, anchoring expectations of future short-term rates and thereby reducing the term premium—the extra compensation investors require for holding longer-term bonds. This compression of the term premium is a key reason why QE lowers long-term yields beyond what simple supply-demand mechanics would predict. The effect is not permanent; once the central bank signals tapering or ends purchases, yields can rise again, which is why communication about QE is as impactful as the purchases themselves.