QE 3 Sets Sail…We’ll Get Back to You on the Return Date
The Federal Reserve has embarked on its latest effort at juicing the economy, an effort referred to as QE 3, or quantitative easing (3rd try). Unlike previous efforts, the Fed has stated that it will continue its practice of buying longer dated mortgage securities until there has been a significant impact on the unemployment rate. The Fed has a dual mandate, which is to mind the store on inflation and to promote full employment. The inflation-snuffing role has been dominant in our lifetimes, but the employment-stoking role, considerably more challenging, is a relatively new focus of Fed Policy. Of course there is always the risk that if the Fed overstays its welcome as the world’s biggest bond buyer, it could lay the seeds for its next big job: combating the inflation it helped create. Right now, with considerable slack in the economy, high levels of unemployment and a dearth of animal spirits, inflation is not a problem.
Are you wondering where QE3 will take us? Let’s first take a look at QE 1 and QE2.
QE 1 was a bit of a surprise, but was exactly what the doctor ordered. After months of declining asset prices and a general seizing-up of credit, the Fed’s program of buying bonds helped restore essential liquidity to the banking system and lowered mortgage rates. The stock market rose from its low in March 2009 to record an almost 80% gain in about a year’s time. Bonds, on the other hand, went down in price as interest rates on the US Treasury 10 Year benchmark increased by 100 basis points (1%). Why did bond yields go up? Perhaps because there was a perception of the cavalry riding to the rescue of the economy, and that the economy might soon return to “normal”.
In between QE1 and QE2, stocks declined and bonds began to move up in price and down in yield. Eventually, there were calls for more QE, please!
In November, 2010, the Fed initiated QE2, with now predictable results. Stocks rose and bonds declined, although this time the markets moved both in anticipation of QE and after QE was initiated. So stocks began climbing in August and didn’t pause until February 2011, for a total gain of about 30%. Bonds declined in yield and improved in price during the months leading up to the announcement and then sold off over the next 3 months as yields climbed 125 basis points (1.25%).
QE 3 has been a similar journey, although not quite as impactful. As before, stocks moved off their low in early June to move about 15% higher by the time of the announcement on September 13, 2012. Also true to pattern, bonds declined in yield before the announcement, from 2.30% in March to 1.40% in June. Since June and through the Fed announcement, bonds have moved a bit higher, to a range of 1.60% to 1.80%, also holding to the “buy the rumor, sell the news” pattern.
The open ended nature of this program has taken some by surprise and has opened a debate on whether the Fed’s latest actions were necessary or even helpful. Some argue that the Fed’s low rate policy has hurt savers and reduced personal income at a time when consumer spending is important to the economy. Others point out that the Fed seems to be sending a signal that the economic picture is even weaker than most realize, and in effect is discouraging the animal spirits necessary for a vibrant economy. Others speculate that Mr. Bernanke really likes his job and therefore, perhaps politics are at play. Regardless, the markets seem to like sailing on the QE whatever, despite the diminishing marginal returns. Eventually, we will see if these programs have an impact on the real economy. Underlying all this, of course, is the message that the Fed has now done virtually everything it can do and that now it is time for a little elbow grease on fiscal policy. Is anyone in Washington listening?