On Sept. 13, the Federal Reserve’s Federal Open Market Committee (FOMC) announced it will launch an open-ended third round of quantitative easing (QE3) to help spur economic growth and boost hiring. The move came days after the European Central Bank unveiled its own much-anticipated bond-buying program aimed at ameliorating the European debt crisis. The actions of the Fed and the ECB show that, four years after the financial crisis of 2008, central banks are firmly in charge of the global economic agenda.
The Fed’s plan to make a monthly $40 billion purchase of Mortgage-Backed Securities (MBS) was not entirely unexpected. What did merit surprise is the bank’s commitment to purchase these securities indefinitely, or at least until the employment picture improves. In a report called FOMC Meeting Review – From Here to Eternity, Credit Suisse Chief Economist Neal Soss writes that the FOMC’s decision “ushers in a new chapter in unconventional Federal Reserve monetary policy – the Age of Open-Ended Asset Purchases.” When pressed to elaborate on specific conditions that need to be met for the Fed to halt its monthly MBS purchases, Fed Chairman Ben Bernanke remained intentionally vague. “We’re looking for on-going sustained improvement in the labor market,” he said. “What we’ve seen in the last six months isn’t it.”
More to Come: QE 3.5
The Fed’s flexibility also potentially paves the way for a much larger monetary stimulus. Indeed, with Operation Twist set to sunset at the end of the year, the Fed hasn’t ruled out the possibility of additional asset purchases once that program ends. One likely move would be for the bank to buy longer-dated Treasuries outright rather than swapping them for outstanding issues, as it currently does as part of Twist. “As we approach year end, the Fed is likely to replace Twist with an unsterilized Treasury purchase program of at least $45 billion,” Carl Lantz, Credit Suisse’s head of US interest rate strategy, told The Financialist. That would be in addition to the $40 billion per month of MBS purchases. Adding Treasuries to the mix could more than double the size of the monetary stimulus to $85 billion a month. “Depending on how the economy does, overall we are left with the idea that the Fed is ready to increase its monetary stimulus,” Lantz explains.
Despite concerns from the FOMC’s inflation hawks, Bernanke has worked hard over the last several months to make sure the door remained open for more monetary action. His work has now paid off. “The Fed might have demurred and told the public that monetary policy could do no more to spur on recovery,” Lantz wrote in Credit Suisse’s latest US Interest Rate Strategy Weekly. “This is clearly not Bernanke’s style and it’s not what he believes.”
The Fed’s open-ended strategy introduces a level of uncertainty for investors, but Bernanke is going out of his way to indicate to markets that he expects QE3 to be large. “The FOMC is relying on strong language – the depiction of the labor market… plus the press conference – to drive home the idea that this program will ultimately be quite large,” Lantz explains.
The open-ended easing program and the FOMC’s decision to extend its federal funds target rate of 0% to 0.25% at least through mid-2015 suggests that monetary action will be the primary weapon in the battle against economic malaise in both the United States and Europe. With little prospect of more fiscal stimulus, central bankers are now clearly in charge of laying the foundations of a global economic recovery.
As of Sept. 21, Carl Lantz had a long position in US Treasury note futures.
Photo: US Federal Reserve