Saturday, September 15, 2012

What should we make of the NewQE or the Fed's New Stimulus Programme?

The announcement was both expected and unexpected.  
*Some* action had been expected in view of economic recovery that I had, much to everyone's surprise, announced in October last year - but is, as expected, much too slow and is not adding anything much in terms of jobs.  
While the Fed's announcement is far less in quantity than was expected (a total of $85 billion a month, instead of the current $100 billion), the disappointment was compensated for by two new and unexpected dimensions which have been added in comparison to earlier rounds of Quantitative Easing or QE.
The first dimension is the announcement articulates the determination of the Fed to continue providing as much QE as needed till there is "a sustained upturn in the jobs market".  That is a huge change, because it marks official recognition that, in view of the nature of the crisis that we are experiencing, ModernQE is not an "once in a blue moon" action but is going to require more or less continuous injection of QE probably for several years.
Second, ModernQE is tied to purchase of mortgage-backed securities, which means that those who bet on the mortgage market will laugh not just this weekend but for years.
The results of the Fed's new actions will be, on one hand, massive gains for speculators (specifically those who bet on the mortgage market) - so it is no wonder that stock prices jumped to a 5-year high; on the other hand, the result is going to be faster inflation for the average person - still low compared to historic highs, but unwelcome at a time when the real economy is stagnating or growing extremely slowly.  In response to those expectations of faster inflation, it is no wonder that gold prices also jumped up.
By contrast, the Fed expects its actions to result in lower rates for mortgages - but whether that will really happen and, if so, when, and by how much, remains to be seen.  
The Fed also expects investors in mortgage-backed securities (MBS) to move into other assets. Theoretically, that is correct.  But don't expect a very quick move as long as there is a killing to be made in the MBS market.

Further, the Fed expects that businesses will now feel more comfortable about going out and start hiring employees.  

Well, expect a marginal improvement, more in the nature of strengthening the floor than in the nature of adding a new storey.  But the Fed anticipates that the unemployment rate will move down, by the end of 2014 (!), to somewhere between  6.7 and 7.3 percent (versus their earlier forecast of somewhere between 7.0 and 7.7 percent, which was the forecast in June).  My view is that 6.7% may be hit sooner than anyone expects at present, but it won’t be for reasons to do with the Fed’s actions, it will depend rather on clarity about the wider rules of the game such as Frank-Dodd and the Romney versus Obama approach to economic growth versus economic inclusion.

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