- The Fed is increasingly likely to announce a second round of quantitative easing next week, at a scale much below previous financial industry expectations.
- The second round of quantitative easing is now expected to kick off gradually with a few hundred billion in bond purchases over several months.
- In our view, a second round of US quantitative easing isn't necessary to maintain economic growth or to drive the current bull market, and the relatively small scale of the program will probably limit its economic impact.
- Trying to guess Fed policy actions has practically become sport, but it's rarely prudent to presume what it'll do next—and jawboning about action has a lot of the impact actual moves would produce.
For months it's been a question of will they or won't they, but media odds-makers are now betting the Fed will announce a second round of quantitative easing next week. Fresh rumors peg the potential "QE2" at a scale much below previous financial industry expectations—and the lack of "shock-and-awe" was met by investor doubt and disappointment as Wednesday's markets fell on the news. The Nasdaq recovered somewhat by the close.
Quantitative easing is a central bank tactic that seeks to drive down long-term interest rates and increase liquidity, usually through purchases of government securities to instantly increase money supply. The Fed purchased $1.75 trillion of bonds in a round of quantitative easing in 2009 to combat the financial crisis. And in recent months, the Fed signaled intent—but not a firm commitment—to restart purchases to further stimulate economic recovery.
QE2 (the monetary policy, not the transatlantic ship)—if it graces our lives at all—is now expected to kick off gradually with about $500 billion in bond purchases over several months. It's speculated the measured pace and smaller initial purchase amount gives the Fed room to increase bond buying as needed or end the program if it proves unwarranted.
Investors tend to like quantitative easing since some of the resulting liquidity usually finds its way into markets, as well the potential benefit to businesses. In our view, a second round of US quantitative easing isn't necessary to maintain economic growth or to drive the current bull market, and the relatively small scale of the program will probably limit its economic impact.
Quantitative easing can help combat deflation or increase liquidity when it's lacking, but there's little sign either is a problem at the moment (though QE2 does likely create a higher hurdle to fight inflation later). The consumer price index is 1.1% higher than a year ago, albeit price increases are lower than the Fed likes, and all measures of money are growing at positive rates. Additionally, GDP has risen for the past four quarters through Q2 2010 and will likely show growth again for Q3.
Trying to guess Fed policy actions has practically become sport, but it's rarely prudent to presume what the Fed will do next (though the Fed has gotten better in recent years at hinting broadly at next moves). Plus, the jawboning has already had a lot of the impact actual QE would produce. Since Fed chair Ben Bernanke started hinting at QE2 in August, what has happened? Stocks have continued rising, bond yields have remained low, the dollar has weakened against a rallying euro, and US mortgage rates are near all-time lows. These are all aims an accommodative central bank likes.
For the most part, central banks around the world remain cautious and flexible today—which is in our view a prudent stance. Of course, policy errors can happen any time, with negative effects only revealing themselves years down the line.