Friday, September 14, 2012

Fed pulls the QE3 trigger

The Federal Open Market Committee (FOMC) took a bold step today in announcing open-ended purchases of agency mortgage-backed securities.  They also extended their forward guidance from late-2014 to mid-2015.

I like the fact this program is directed again at mortgage securities; that makes it more targeted than QE2 which was solely aimed at Treasury’s.  A stronger housing market is a key component of a stronger and broader economic recovery.

Purchases will be at the rate of $40b per month.  “Operation twist”, in which the Fed is extending the average maturity of its holdings of securities, will remain unchanged and continue on until the end of the year.  This will result in total purchases of longer-dated securities of $85b per month until the end of the year.

This is brave new ground for the Fed.  Up until now asset purchases have been of a fixed quantum and duration.  This time they have said purchases will continue until economic conditions improve.  Furthermore the conditionality is aimed directly at the labour market; perhaps that should be unsurprising in the context of Bernanke’s recently stated “grave concern” about the state of the jobs market.  From the statement:

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

Also unlike the first two asset purchase programs, today’s action has been undertaken when inflation expectations are rising.  QE3 can only add to those expectations of higher longer-term inflation.  That’s not necessarily a bad thing if you think higher inflation is part of the answer to America’s economic woes, but it serves to remind us once again that we should not make conclusions about the success or otherwise of quantitative easing until we have been through a full cycle and the stimulus has been exited.

I worry a bit about collateral damage.  The New Zealand dollar is at 83 cents against the USD this morning.  That makes life harder here.  I also worry about the impact on commodity prices and the extent to which stronger (soft) commodity prices may limit stimulatory policy action in some emerging economies, particularly China.

One last point before we go back to enjoying the rally.  As we said about the ECB last week – central banks can’t fix all the problems.  Maybe, like the ECB, the Fed has now created a window of opportunity for policymakers to get on with the job of building a stronger and more enduring economic recovery.  But perhaps we have to wait until after the election?