The central banks buy US stocks

Buying securities through central banks - a game with ups and downs

Central banks have a decisive influence on developments on the stock exchanges. When central banks buy securities such as government bonds en masse and put money into circulation, this usually has the following effect:

Investors' capital flows to where they expect the best combination of security and return, often in stocks, precious metals or real estate.

Central banks buy securities to regulate the market

But in the case of central bank interventions, on the one hand, the prices of these asset classes are sometimes on a shaky footing.

On the other hand, even government bonds from crisis countries can turn out to be bargains for those who are risk-conscious.

Central banks intervene in times of crisis. Your core task is to maintain price stability.

But they also intervene in the market if the economy continues to be paralyzed, market disruptions or high national debt. This mostly happens on in support of the economic policy. Formally, of course, the governments cannot force the independent central banks to take certain actions. Nevertheless, it can be observed that the central banks cannot evade (indirect) (political) pressure de facto.

Such interventions by the world's most important central banks have been observed since the successive crises of recent years, whether in Japan, the USA or the euro zone.

An important tax instrument for this is called open market policy. This includes the direct purchase or sale of securities by the respective central bank. At the European Central Bank (ECB), this trade only takes place on the secondary market.

The direct purchase of bonds from issuing countries or companies is prohibited for the ECB.

If the central bank buys government bonds in large quantities, it puts money into circulation. This money leads to a higher demand by the economic subjects and thus stimulates the economy.

At the same time, interest rates are falling, making it cheaper for states, companies and private individuals to borrow. This is a signal for the markets.

Central banks buy securities: effects on stock exchanges and investors

The prices of bonds already traded on the market go up when yields fall, so they behave in opposite directions. Previous owners can reap price gains. If the central bank has announced that it will carry out these purchases over a longer period of time, new investors can also expect future price gains.

In fact, investors who had invested in bonds from problem countries such as Italy or Spain at the beginning of the ECB's buying activities were able to reap considerable profits. The reason is the increased prices.

The danger here: if the central bank interventions ultimately prove unsuccessful, government bonds will be sold in rows. That would ultimately be a kind of credibility problem vis-à-vis the central bank. What was remarkable in this context was the fact that during the critical period there was a very strong flight into German government bonds in particular. Some of these had price gains of well over 50% within a year, and thus more than with stocks.

In the expectation that the central bank interventions will stimulate the economy at the same time, a lot of investment capital flows into shares. And another point that has recently been important: there is a lot of money in circulation, but because of the low interest rates, investments in stocks are almost exclusively attractive.

The indices are pointing up. But the global economic, national or company-related fundamentals do not always match the stock market euphoria. If these do not even out at some point, there is a risk of a significant correction in the markets.

In search of safe havens, many investors invest in precious metals or real estate. In the long term, however, that is not without risk.

As soon as times change, the already inflated price drops again. You should therefore always make sure that the prices you are paying for your systems have not already overheated. This phenomenon can be observed over and over again for basically all markets (whether stocks, real estate, precious metals, raw materials, interest rates).

What alternative do investors have?

If the central banks intervene in the market by buying securities, volatilities and prices are to be expected that will not withstand reality in the long term.

So investors have to act quickly and skillfully. The safer alternative is rather a long-term investment over troubled times with a portfolio that is as broadly diversified as possible.

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