Fed Delves More Deeply Into Quantitative Easing

March 18, 2009

The FOMC announced more dramatic steps than anticipated but left the federal funds target at a 25-basis point range centered on 0.125% rather than drop such to a point target of zero as Japan did when it eased quantitatively earlier this decade.  Steps being taken by the Fed to get credit to the housing market and to small firms and household are

  • A 66.7% increase to $1.25 trillion in the ceiling of agency mortgage-backed securities that the Fed will purchase to bulk up its balance sheet.
  • A 100% rise $200 billion in agency debt to be bought.
  • Launch of a plan for buying up to $300 billion of longer-dated Treasuries during the next six months.  At the prior meeting, officials indicated this kind of action was being considered.
  • Promising to broaden the range of eligible capital for TALF.

The FOMC decided on these actions by a unanimous 10-0 vote.  Jeffrey Lacker, President of the Richmond Fed, had dissented in January, urging then for the Fed to begin buying longer-dated Treasuries.  The other committee members have now moved in his direction.

A number of semantic modifications were made to the discussion of economic conditions and prospects.

  1. Energy and commodity trends were no longer cited as a disinflationary factor.
  2. Inflation is still expected to be too low.  However, the modifying phrase, “in coming quarters,” was dropped from the asserted expectation that inflation will remain subdued.
  3. Instead of mentioning significantly slower global demand, the FOMC now points out that several major trading partners are in recessions.
  4. A weakening U.S. economy is now said to be contracting.
  5. January’s statement enumerated weak U.S. indicators such as employment and industrial production.  Today’s cites forces that are weighing on consumption, fixed investment, and the management of inventories.
  6. Financial conditions in January were called “extremely tight” and are characterized now as “tight” for consumers and “difficult” for businesses.
  7. January’s statement “anticipated a gradual recovery in economic activity beginning later this year.” Now officials speak of “a gradual resumption of sustainable economic growth” without saying when such might start.

The FOMC has combined more forceful-than-anticipated incremental credit stimulus with somewhat less pessimism about economic prospects, which seems to dovetail with Chairman Bernanke’s remarks Sunday in an unprecedented interview on the TV show, 60 Minutes.

The extent of the market’s surprise and the influence the Fed hoped to exert in the market were clearly on display over the 45 minutes immediately following the FOMC announcement.  First, don’t listen to what officials say regarding competitive devaluations, watch what they do.  The dollar fell 2.2% against the euro and yen and by 1.6% against the Canadian dollar.  Second, don’t worry about the Treasury market absorbing massive new federal borrowing.  The Fed will ensure low long-term rates upon which mortgages and all sorts of other consumer and business loans depend.  Ten-year Treasury yields fell 38 basis points, 3/8ths of a percentage point.  The FOMC ran out of room to cut short-term rates, but a 38-bp cut at the long end will provide even more support than if all the Fed had done was cut short rates by that amount or even 50 basis points.

A third target of Fed policy changes was to pare back the adverse wealth effect that the statement identified as “weighing on consumer sentiment and spending.”  This means taking actions to stimulate private domestic demand but also to buoy the mood.  The more hopeful characterization of economic prospects may represent more than officials believe.  If people believe what officials tell them, it’s important for the public message to accentuate the positive.  Equity wealth represents a far bigger loss of household wealth since the start of this year than real estate wealth. Within 45 minutes of the announcement, the DOW had risen 3.0% and the Nasdaq was up by 2.2%.

A 1.9% rise of oil prices obviously was not also in the Fed’s intended reactions but rather represents collateral, albeit predictable, damage.  Throughout the credit crisis, oil and the dollar have moved inversely.  Oil peaked on July 15th at $147.27 per barrel, and the dollar bottomed that same day at 1.6038 per euro.  U.S. GDP performed better when oil prices were elevated and rising.  If higher oil costs are needed to stabilize the financial markets and real economy, it will be worth it.  Moreover, experts seem to thing that oil price equilibrium lies at around $75, well above current levels, and higher oil costs are needed to promote long-term needs like the development of alternatives to fossil fuel to reduce dependency on unfriendly foreign policies in the Middle East, Russia, Nigeria or Venezuela.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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