QE II: All But Baked In?

September 25, 2010

It may not taste that good, but looks increasingly baked in the cake. After this week’s dovish policy statement from the U.S. Federal Reserve, many investors are looking for the central bank to ease monetary policy further in November or December, barring some unexpected turnaround in the economy. A Reuters poll of U.S. primary dealer banks taken right after the decision  showed 10 of 16 believed the Fed would boost its bond-buying program in coming months. Of those, seven saw the move coming in November, and the others shortly thereafter. As economists at JP Morgan put it:

Tuesday’s FOMC meeting reinforced the message that the
Fed is moving toward additional large-scale asset purchases
(LSAP). The first hint of a shift in policy came from
the decision to reinvest the paydown of MBS into Treasuries
announced at the August 10 meeting. This was followed
by Chairman Bernanke’s discussion of the efficacy of alternative
policies to support growth, focusing on asset purchases,
in his August 27 Jackson Hole speech. This week’s
downbeat growth assessment and statement that the committee
is “prepared to provide additional accommodation if
needed” signals that the Fed is now likely to embark on
Treasury purchases before year-end.

Tuesday’s FOMC meeting reinforced the message that the Fed is moving toward additional large-scale asset purchases. This week’s downbeat growth assessment and statement that the committee is “prepared to provide additional accommodation if needed” signals that the Fed is now likely to embark on Treasury purchases before year-end.

Market reaction was decisive: bond yields and the U.S. dollar retreated sharply while gold marched to fresh records, all in preparation for another round of quantitative easing.  The central bank’s latest pronouncement seemed to shift the goalposts from Fed Chairman Ben Bernanke’s Jackson Hole speech in late August. Rather than wait for things to get worse, the Fed may act simply if anemic conditions fail to improve. Tom Porcelli at RBC comments on the subtle but important distinction:

The Fed essentially lowered the bar set by Bernanke at Jackson Hole when he noted it would take increased deflation risks for the benefits of further action to outweigh the costs. The Fed is now seemingly concerned, not only about deflation risks, but about inflation trending below their comfort zone (unofficially 1.5-2.0%).

It was first time “in at least a half century” that the Fed expressed explicit concern about prices rising too slowly, say economists at Goldman Sachs. The language may in part have been an effort to win over Fed hawks by framing the argument in terms they will find harder to ignore, while still leaving the door open to using demand indicators to guide policy.

Whether any new easing will work as intended is another matter. But Fed-watchers scavenging for dovish crumbs in the Fed’s policy outlook had to look no further than this key sentence in the Sept. 21 communique:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.

Unless that trend is reversed in a hurry, which looks unlikely, QE II may already be in the oven.

2 comments

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I would find this discouraging if I hadn’t already acquired a reasonable amount of gold.

Bernanke is more frightened of deflation than inflation. He is perhaps delusional about his abilities to control inflation when it arrives, talk about on the job training.

Quantative easing is just a derivative way of printing more money, attempting to devalue the dollar. The problem is that once the lid comes off pandora’s box, all the evil goblins are released.

The first house I ever purchased had a 15.5% mortgage–thank you Jimmy Carter….

Posted by PhilGrimm | Report as abusive

Why isn’t this labeled as ‘currency manipulation’????

Posted by edgyinchina | Report as abusive