SINGAPORE (Aug 11): Forget the US Federal Reserve’s rate hikes. There is far more to be feared from the imminent reversal of quantitative easing (QE) by both the Fed and the European Central Bank (ECB).

In the aftermath of the global financial crisis, the positive correlation between the fed funds rate and the Dow Jones Industrial Average appears to have broken down. Unorthodox central bank actions appear to have affected this relationship.

In efforts to shore up confidence and stimulate flagging growth, central banks in developed markets resorted to bond buying programmes. These QE actions injected massive liquidity, stimulating growth and driving up asset prices.

The primary reason for this unorthodox policy was that the traditional monetary tool of lowering interest rates was no longer effective, given that interest rates were already zero or near zero and the crisis was one of confidence and high household debt.

Buying by central banks fed a multi-year bond rally, while yields for the highest-quality government securities were driven down to near zero, even into negative territory. Remember: bond yields fall as prices rise.

The massive liquidity spilled over into equity markets.

With bond yields at historical lows, investors looked to stocks with high dividend yields and emerging markets for better returns.

As they took on more risks, unlisted and private-equity deals mushroomed. Property prices from Vancouver to Melbourne have since risen to record highs.

The trillion-dollar question is: what happens when central banks stop buying bonds and start shrinking their balance sheets?

Find out the full story behind the risks in “Beware of rising yields on reverse QE” on page 6 of The Edge Singapore (week of Aug 14), available at newsstand now.

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Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore.