Quantitative easing is the process of printing money to stimulate the economy.
Major central banks tend to use this practice when their economy needs a boost. The global financial crisis of 2008 is a good example of this.
As the global financial system ground to a halt, central banks acted to inject capital into their economies.
Exploring The Financial Crisis
Normally, private banks create new money to loan out to people and businesses.
The financial crisis caused private banks to panic and stop lending. As a result, the creation of ‘new money’ significantly dropped.
Despite this, people and businesses continued to pay back existing loans with interest.
However, if this had continued, there would not have been enough ‘new money’ in the system to cover interest payments on the existing loans.
The Role Of Quantitative Easing
To stop the amount of money in the economy shrinking, central banks use quantitative easing.
It involves printing ‘new money’, before using it to buy government bonds. By doing so, central banks make government bonds less attractive to investors in terms of price and yield.
Therefore, investors are likely to move their capital to private equities or property (investments that help boost economic growth).
Quantitative easing can also involve central banks buying private bank bonds. This encourages private banks to lend, helping to fuel economic growth.
The Effects Of Quantitative Easing
Quantitative easing has two effects.
Firstly, it helps asset prices (such as equities and property) increase, as investors move out of bonds.
Secondly, it devalues the native currency value, as its supply is dramatically increased.
The effectiveness of quantitative easing as a monetary policy tool is widely debated. As traders, we are simply interested in how to profit from quantitative easing.
How To Trade Through Quantitative Easing
During a period of quantitative easing, you should expect the value of the native currency to devalue.
Typically, sell-offs occur over weeks and months.
This period gives you ample opportunity to profit from central bank policy shifts.
There are two main ways to make money from trading quantitative easing moves:
- When the central bank first announces its quantitative easing programme. The market is likely to react sharply to the news.
- Over the quantitative easing cycle. Traders that hold short positions on the native currency are likely to profit over an extended period.
What Is Quantitative Easing?
When a central bank starts to reduce its quantitative easing programme, the value of its currency then starts to rise.
The key to your success lies in monitoring the financial news.
Keep an eye out for monetary policy announcements from major central banks. Plus, listen out for adjustments to existing quantitative easing programmes.
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