Question

In analyzing the economic and financial market impacts of the QE announcements, what are the probable reasons for the changes in behavior of:

• long-term and short-term rates,
• credit default swaps, and
• inflation expectations.

Answer 1

Reasons for the change in the behaviour of-

1. Long and short term rates-this could be changed through structural change in demand and the Federal Reserve wants to control the money supply into the economy.if Federal reserve is cutting the rates, it means that it was to stimulate the demand while if Federal Reserve is increasing the rates, it means the Federal Reserve is controlling the the money supply in the economy.

2. Credit default swaps-this could be impacted by the credit risk associated with different type of loan as well as the default risk which are associated with different types of loans. If the risks goes up, default swaps are highly vulnerable.

3. Inflation expectations-if there is a high expectation of inflation in the economy, the Federal Reserve would retaliate by increasing the overall interest rate into the economy, and if there is a low expectation of inflation in the economy, the Federal Reserve would cut the interest rate in order to stimulate the demand and to increase the money flow in the economy.