The Fed's announcement to expand the asset purchase program with
an additional $40 billion in mortgage-backed securities per month
was a fairly aggressive step, particularly given that we're less
than two months away from a presidential election. This move,
coupled with the extension until mid-2015 of the guidance to hold
the Fed Funds rate between zero and .25%, suggests the Fed
continues to be extremely concerned with
weakness in the labor market
Unfortunately, this third round of quantitative easing (QE3)
won't be a particularly effective parachute if the U.S. economy
goes over the fiscal cliff. While the Fed's announcement inspired a
market rally driven by
investors' increased tolerance for risk
, it's unclear clear whether QE3 will change much in the long run.
Other than providing additional liquidity to an already flooded
banking system, the policy will likely have little impact on the
The prospect of unlimited buying of mortgage-backed securities
will help keep mortgage rates low for a long time, but they were
already low. In July, a conventional 30-year mortgage could be had
for 3.75%. It's unclear whether a potential 50 basis points
reduction in mortgage rates will spur a housing renaissance.
My view is that while the housing market is clearly on the mend,
it is going to be a long convalescence, and there is probably
little the Fed can do to expedite the process. The major problem
for the U.S. economy is a lack of aggregate demand due to prolonged
consumer deleveraging. Nothing in the Fed's monetary toolkit is
likely to change that.
The Fed can also do a little to mitigate a more imminent threat
to the recovery: the fiscal cliff. Should the pending tax hikes and
cuts to transfer payments hit on schedule, this will be a
significant blow to a consumer still struggling with too much debt
and little income growth. A nominal drop in interest rates,
assuming this happens, would do little to cushion the blow.
While the most likely scenario is that Washington reaches a
compromise at the last minute, until then the uncertainty will keep
the markets volatile and potentially drag down fourth quarter
growth. Given recent comments out of Congress, there is also a
non-trivial chance that we will, at least temporarily, go over the
cliff. If that happens, QE3 will not be a particularly effective
Tuesday: Bernanke Promises Qinfinity And The
Markets Shrug It Off?