Fed Pledges $480B A Month In Bond Purchases, Promises More To Come

QE2 totalled $600 billion in Treasuries and MBS purchases.  QE3, by contrast is only $40 billion a month in MBS – just $480 billion in a year. So what makes this asset purchase program different?

  • It’s open ended –we don’t know when they’ll stop expanding the balance sheet
  • The Fed says it can add to these purchases by beginning to buy Treasuries as well 
  • The Fed said they can use “other policy tools” if labor markets don’t improve.

PNC Economist Gus Faucher says that the purpose was to assuage fears that the Fed was falling behind:

With the unemployment rate still above 8% and payroll job growth of less than 100,000 in four of the past five months, the FOMC was concerned that the labor market recovery remains too slow. At the same time inflation is low, with no indication that it is set to pick up, outside of volatile food and energy prices.

The FOMC action should bring down mortgage rates and spur a faster turnaround in housing. Construction is up, sales are improving, and prices for existing homes are increasing, but the level of housing activity is still far below normal. The FOMC is expecting its actions to speed up the housing recovery, although tight credit remains a concern.

Perhaps more importantly, today’s moves are designed to convince financial markets that the FOMC is still on the case, and will take further steps as needed to accelerate the recovery. This should help keep long-term interest rates low and boost confidence, contributing to stronger overall economic growth.

Not Unexpected But As Always A Twist

Doing the Minimum Yet Again: Many market players and analysts had expected QE3, but the fact that the Fed decided to buy purely mortgage-backed securities and no Treasuries, was surprising. Also surprising is Bernanke’s statement that there are still more weapons stashed in the Fed’s arsenal:

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

In other words, this isn’t full-blown QE3, it’s partial QE focusing only on mortgages with the apparent intention of propping up market psychology and, more importantly, supporting the housing market.

Targeting Unemployment: ITG’s Steve Blitz describes this as a move specifically targeted to the unemployment rate:

This is now effectively a monetary policy with a single rather than dual objective – getting the unemployment rate down. Bernanke said at Jackson Hole he rejected the structural argument for continued high long-term unemployment and he is now out to prove it. What we don’t know, and the guessing game now begins – what exactly is a substantial improvement in the labor market.

In sum, the Fed did the minimum to meet market expectations. They did not meet the more aggressive expectations of balance sheet expansion because the economy does not at the moment justify that kind of action. The FOMC is, however, clearly worried about the economy going forward and will do more if necessary, we just don’t know what metrics will make necessary, necessary.

Congress’ Inaction Leaves Us With the Fed: Some economists like the inflation-fearing Ameriprise senior economist Russel Price seem to think it’s too much. One wonders what planet he resides on. Perhaps he missed the fact that, since the House Republicans filibustered the jobs act, it looks like we are forced to fall back on the Fed’s limited tools. He writes:

I believe the Fed has already reached the point of diminishing returns on its bond-purchase programs and further action could do more economic harm than good. Most notably, the added liquidity being supplied by the Fed in its effort to create some demand-driven inflation is instead more-often-than-not generating the unwelcome result of supply-push inflation. Evidence from the Fed’s prior quantitative easing efforts suggests that the added liquidity supplied to the financial system is largely flowing into commodities and financial assets. It should be noted that even core producer prices, as reported in this morning’s Producer Price Index, were running at a hot 3.6% on a three-month annualized rate. This data point could complicate the FOMC’s policy discussions.

The Fed In Plain English

Forbes, in reporting the news, translates some of the Fedspeak used to justify the new action:

Fedspeak: Economy “continues to expand at a moderate pace.”

English: Economy is caught in a rut, or one speed, and failing to reaccelerate. (Aka live up to the Fed’s dual mandate.)

Fedspeak: “Growth in employment has been slow.”

English: See above comment

Fedspeak: “Business fixed investment appears to have slowed.”

English: No it HAS slowed as evidenced by a warning from Intel (INTC) and lukewarm mid-quarter update from Texas Instruments (TXN).  This comment also a head nod to fiscal policymakers, there has to be some reason why cash rich balance sheets are not being utilized (there are…tax uncertainty)

Here’s the statement from the Fed:

Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months.  Growth in employment has been slow, and the unemployment rate remains elevated.  Household spending has continued to advance, but growth in business fixed investment appears to have slowed.  The housing sector has shown some further signs of improvement, albeit from a depressed level.  Inflation has been subdued, although the prices of some key commodities have increased recently. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.  Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.  The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
The Committee will closely monitor incoming information on economic and financial developments in coming months.  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.  In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.  In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.  Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for the federal funds rate are likely to be warranted.

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