QE3: Ineffective Parachute for Fiscal Cliff

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By Russ Koesterich :

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 underlying economy.

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 parachute.

Source: Bloomberg

Original Post

See also Tuesday: Bernanke Promises Qinfinity And The Markets Shrug It Off? on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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