THE FED ANNOUNCES QE3
A look at the central bank's latest strategy.
One more round of easing brightens the mood of Wall Street. With the fiscal cliff roughly 100 days away and the first Tuesday in November still too far off, institutional and retail investors were counting on the Federal Reserve to combat market anxiety with a new stimulus. In its latest policy announcement, the Fed came through - on September 14, the central bank launched its third round of easing in the past four years.1
How does QE3 compare to QE2? Well for one thing, QE3 is open-ended. The Fed will purchase $40 billion of agency mortgage-backed securities per month, until it decides otherwise. It is also continuing its Operation Twist bond-swap program through the end of 2012, meaning that the Fed will be adding $85 billion worth of long-term securities in each of the last four months of this year.1
Additionally, the central bank reinforced its pledge to keep interest rates at record lows "at least through mid-2015."1
During QE2 (November 2010-June 2011), the Fed incrementally bought $600 billion in longer-term Treasuries and reinvested payments on $1.25 trillion of mortgage-linked securities it purchased from banks during QE1 (November 2008-March 2010).2,3
What could QE3 potentially accomplish? Ideally, QE3 will aid the stock market, the housing market and by extension the job market. By buying mortgages, the Fed is seeking to accelerate the promising rebound in the real estate sector and keep long-term interest rates low.
Did the announcement live up to expectations? The Dow soared 100 points just minutes after announcement of the policy statement, so any thoughts that the market had priced QE3 in initially appeared inaccurate. The CBOE VIX (the so-called "fear index") slid below 16 on the news. In short, the market got what it wanted - and the summer rally found a little more momentum.4
As Bank of Tokyo-Mitsubishi chief financial economist Chris Rupkey commented to CNBC.com this week, this rally has been fueled largely "on hopes for QE3 even as investors believe QE3 will have virtually no effect. The market does not seem to know what it wants, but the Fed is going to give it to them anyway." BlackBay Group managing principal Todd Schoenberger seconded that notion: "This rally's been based on a 'Bernanke bubble' ... if he doesn't come through with another round of QE, it's going to be a big disappointment."5,6
With the Fed more or less saying that easy money will be available for some time, you might say the markets are pleased.
Is QE3 really necessary? Stocks have performed better than many analysts expected this summer, thanks in part to renewed hope that the European Union will solve its debt crises. With the markets at multi-year highs, some analysts felt that the Fed should have refrained from further stimulus measures.
In a September 12 CNBC survey of 58 noted money managers, strategists and economists, 59% of respondents felt QE3 would do nothing to reduce the jobless rate. That said, the Fed obviously saw merit in easing before the economy approaches the edge of the fiscal cliff.6
Central bank easing doesn't always realize its aims. Looking back, we can see that QE2 had some unexpected effects. Many economists and housing industry analysts assumed that it would drive mortgage rates lower. It didn't. In fact, interest rates on 30-year fixed-rate mortgages climbed about 30 basis points during the program. Six weeks after QE2 started, rates on the 30-year FRM had jumped nearly half a percent.2
What might happen in the near term? Hopefully the Fed's action will give stocks a shot in the arm for fall and winter, strengthen the residential real estate market and show support for both Wall Street and Main Street. Let's hope that this major announcement leads to a major improvement for the broader economy.
Citations.
1 - www.marketwatch.com/story/fed-to-launch-qe3-of-40-billion-mbs-each-month-2012-09-13 [9/13/12]
2 - www.bankrate.com/finance/federal-reserve/qe2-financial-crisis-timeline.aspx [9/21/11]
3 - www.bankrate.com/finance/federal-reserve/qe1-financial-crisis-timeline.aspx [9/21/11]
4 - www.bankrate.com/finance/federal-reserve/qe1-financial-crisis-timeline.aspx [9/21/11]
5 - www.cnbc.com/id/49002386 [9/12/12]
6 - www.cnbc.com/id/48990032/ [9/12/12]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
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