I’ve spent an excessive amount of time in the last 7 years talking about the various market distortions that QE can cause (I even dedicated a paper to the commodity bubble in 2011).  I would argue that the two primary places where these distortions occurred were in the commodity markets and the corporate bond market (though probably less directly attributable in the commodity market).

The thinking relative to commodities was very simple.  QE created the belief that high inflation was on the horizon so commodity producers saw huge inflows of demand for “real assets”. There were all sorts of strange things happening in the markets over the last 7 years including Chinese farmers hoarding cotton in their kitchens, copper producers essentially securitizing their holdings to make loans, investment banks holding inventories of oil, etc. These were moves that were designed to anticipate the coming inflation from QE’s “money printing”, which never came of course because QE doesn’t create high inflation (as I’ve repeatedly explained).¹

The current debacle in commodity markets goes beyond the slowdown in China. It is, to a large degree, a capitulation in the idea that QE causes high inflation. This has been most notable in the precious metals markets which are often viewed as the best commodity to hold to protect against inflation. Back in 2011 I explicitly stated that the silver market was in a bubble with prices over $40. The current collapse is a complete reversal in the “QE causes inflation” view.

The more recent market debacle is occurring in high yield bonds which has similar bull market origins. This is another market that I’ve expressed concerns about over the years thanks to distortions from QE. Again, the thinking is very simple. QE reduces the quantity of safe high(er) yielding fixed income assets in the private sector. As the private sector is forced out of these holdings they search for similar alternatives. Since the safest high(er) yielding instruments have been removed from the aggregate pool of options investors have no choice but to demand alternatives. QE essentially dilutes the quality of the outstanding pool of options forcing investors to reallocate into riskier alternatives.