Investors are struggling to accept end of U.S. easing

June 23, 2011

By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The Federal Reserve’s $600 billion Treasury bond-buying program, known as QE2, is ending. At least a few investors are ready for QE3, despite no hint of it from the U.S. central bank. Though some in the markets might want it, further monetary stimulus is a bad idea.

PIMCO’s Bill Gross has even suggested the Fed could cap longer-term interest rates than the overnight rate it traditionally targets and currently aims to keep in the zero to 0.25 percent range. That sounds like the talk is moving into absurdist territory — except that Fed Chairman Ben Bernanke staked out the ground nearly a decade ago.

Gross has taken up the cause using his Twitter account. He has said over the last week that caps on longer-dated yields — two years, say — could become a reality. The United States did something like that in the 1940s. And Bernanke, in a 2002 speech, said the central bank could suppress yields by “committing to unlimited purchases of securities up to two years from maturity.”

But today’s realities make such a move unlikely. The Fed now holds a massive $2.8 trillion of assets, up from around $900 billion in August 2008. That’s already a sore point inside the Fed — let alone outside, especially among critical Republican lawmakers. The latest round of quantitative easing may have helped boost stock markets and confidence, but it’s hard to conclude it fueled economic growth or the housing market, the U.S. economy’s biggest drag. There are costs to lax monetary policy. The Fed saw the benefits of QE2 as outweighing those, but that’s a harder case to make each time.

Committing the Fed to unlimited further expansion of its balance sheet could provoke an internal revolt and would certainly trigger political attempts to end the institution’s cherished independence. Even if the economy worsens, Bernanke would have a tough time selling more easing.

With inflation at least temporarily rising, he isn’t trying to do that right now. Investors need to recognize how little more the Fed can do. As the bank’s officials have noted, fiscal stimulus has a far more direct effect — though that, too, would offer diminishing returns even if it didn’t look politically impossible. It’s time for markets to tough out the sluggish recovery on their own.

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