Sober Look talks about two risks of ultra easy monetary policy a few days ago (link here):
What many economists failed to realize - and many continue to do so today - was that the risk of excessive liquidity is not necessarily the overall price inflation.
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As an example of where this excess liquidity may be ending up today, consider the fact that the average US corporate junk bond yield ended up at an all-time low of 5.93 last week (chart below). Of course market participants have dozens of ways of rationalizing this trend - just as they did with other markets many times before.
As stated in the article, inflation is a risk of ultra easy policy. However, because the Federal Reserve can now pay interest rate on reserves, this risk can be controlled somewhat. The other risk – that of asset bubble – is not as easily tweak-able. Blindly chasing yield while ignoring risk is bad, but price inflation of assets such as MBS and corporate bonds is a channel of monetary policy to encourage economic growth. From Chairman Bernanke’s speech back on August 27, 2010 (link here), with emphasis added by me:
The channels through which the Fed's purchases affect longer-term interest rates and financial conditions more generally have been subject to debate. I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which holds that once short-term interest rates have reached zero, the Federal Reserve's purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public. Specifically, the Fed's strategy relies on the presumption that different financial assets are not perfect substitutes in investors' portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration. For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.
The Federal Reserve hopes that investors would buy more high-quality corporate bonds, but Sober Look finding indication that perhaps investors are buying quite a bit of low-quality corporate bonds also.