Has the Federal Reserve just disappointed everyone?

In my earlier post of today I suggested that the FOMC would probably do the following. Around US $500 billion of new asset purchases or Quantitative Easing and that many had forgotten the existing programme of QE-lite that the Federal Reserve could use to tweak its actions even higher.

The Announcement from the FOMC

The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The FOMC also directed the Desk to continue to reinvest principal payments from agency debt and agency mortgage-backed securities into longer-term Treasury securities. Based on current estimates, the Desk expects to reinvest $250 to $300 billion over the same period, though the realized amount of reinvestment will depend on the evolution of actual principal payments.

Taken together, the Desk anticipates conducting $850 to $900 billion of purchases of longer-term Treasury securities through the end of the second quarter. This would result in an average purchase pace of roughly $110 billion per month, representing about $75 billion per month associated with additional purchases and roughly $35 billion per month associated with reinvestment purchases.

Explanation of what has happened

The FOMC has decided to announce a flow of asset purchases and continue with its existing programme of QE-lite. Accordingly it will buy around US $110 billion of US government debt per month if you combine the two in what will now be called QE2.

There was a debate as to the maturity of the debt which will be purchased. The FOMC has confused itself on this issue in the past but it has indicated that it will buy in the 5 to 6 year maturity as an average. This might seem very technical but for those who hold say the 30 year benchmark this does matter because it implies either none of these or very few will be purchased by the Fed and maybe fewer ten-years than the market had factored in. So we could see falls in their prices with the 30 year likely to fall by more.

You could argue that this is US $600 billion or US $900 billion so markets may be confused for a while as this is digested.

Initial Comment

I wonder if this announcement will disappoint everyone. It disappoints me as I think it is a policy error. But those in favour of it have gone for higher numbers than this in their attempt to show a likely economic effect from QE2. As I read some more I see this in the announcement and the emphasis is mine.

Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters… measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.

There is a clear hint for future policy there and also for inflation prospects. It is not entirely a cunning plan to suggest you are going to try to raise inflation when you are trying to reduce long-term interest rates.Perhaps that is why these are called extraordinary monetary measures!

Over to you Bank of Japan,Bank of England,European Central Bank


9 thoughts on “Has the Federal Reserve just disappointed everyone?

  1. “The FOMC also directed the Desk to continue to reinvest principal payments from agency debt and agency mortgage-backed securities into longer-term Treasury securities.”

    “This would result in an average purchase pace of roughly $110 billion per month…”

    Am I right in thinking that this means there will be a slow shift in the Fed’s holdings away from agency debt and MBS towards treasuries? i.e. a ‘qualitative tightening’ of $35 bn per month? Are we starting to see a glimpse of their exit strategy here?

    • Hi Graham

      As the mortgage debt appears to be expiring/maturing more quickly than the Treasuries then I think that we are moving away from an exit strategy by default.

      the news is till early and we need to find out what they mean by longer-term as last time the FOMC confused itself and misled the whole bond market for the best part of an hour…..

      • From the FT –

        In a separate statement the Federal Reserve Bank of New York said that it would seek to buy securities with an “average duration of between 5 and 6 years”.

        I was thinking that if they want to prepare for tightening in the medium term, they need to make sure that the assets they hold on their balance sheet by then are not too sensitive to rate rises (i.e. average maturity not 10 years+). If the Fed really wanted to prop up the consumer via mortgage rates, it would focus on MBS and long-dated treasuries, no? Whereas if it wanted to protect itself from losses, alleviate the government’s debt rollover issue, and help the financial sector recapitalize/profiteer, then it would make sense to purchase treasuries at the short end of the spectrum…

        • Hi Graham

          Apologies we were at slightly cross purposes. The choice of 5 to 6 years is interesting and goes against the expectations of Goldman Sachs who for example were looking for a longer maturity and more purchases of the 30 year benchmark. There are 4 possible answers to this I think.

          1. A type of passive exit strategy as you suggest.
          2. Matching the purchases with the likely structure of US debt as a Treasury meeting recently had suggested lengthening of the average maturity, which I guess will now aim at 5 to 6 years.
          3. They feel for some reason that buying in this area and lowering rates will have the best effect.
          4. They did not want the supposed additional stimulatory effect of buying more longer-term bonds.

  2. Why is it that these figures are not annualised in the same way as US GDP figures? With QE2 they speak only of “monthly” and “quaterly”. If what the FOMC has announced is the “right thing” to do for the US economy then why are they so obfuscatory with the simple truth?

    Annualised QE-Lite and QE2 together would total somewhere around US$1.7T to US$1.8T. Certainly doesnt look to me like they’ll be looking for an exit strategy any time soon since these (annualised) figures would seem to suggest that QE2 is larger than the original QE by some distance.

    On another note… I just watched a cringe worthy half hour of self-congratulatory back-slapping on CNBC which ended abruptly when they interviewed a US economist who stated that he was now really scared that, at some point in the next few years, the FED will lose control of the bond market and interest rates will sky rocket. For some reason that wiped the smile off all faces in the studio, (which was nice 🙂 )

    Im the first to confess that I dont know much about bond markets but I think I do grasp how the FED controls the market right now. My question is, how could they possibly lose that control? That is something I cant get my head around.

    Once again cheers for the blog. A great daily read.


    • Hi Zak

      You pose several questions. If we look at annualisation then we are thinking of it as a flow so 110 billion a month for example which you could annualise. However I think they are still stuck between whether it is a stock as in a total of 1.7 trillion on a balance sheet or a flow.So in their move from one to another or stock to flow I think that they are exhibiting confusion… Put another way they only want to commit for the short term because in my opinion they do not know how much is enough. I rush to say they because I do not believe it will work at all and fear it may make things worse.

      As to losing control of the government bond market I believe that in some respects they already have. One way of thinking of today’s move is like a junkie’s fix. They take it once the pleasurable phase has passed because they are afraid of withdrawal symptoms. So yes they have control but at the price of being a junkie and in my view each fix makes it more likely that they will lose further control in the future.

      Actual loss of control could come via the exchange rate. Imagine the IMF being called in to help the US.

  3. For the most part, it was party time on the stock exchanges today.

    Yet, I believe A Rally Top Was Achieved On November 3, 2010, As Equities And Bonds Both Moved Higher With The Announcement Of QE2, And Now A Currency Sell Off Is Imminent

    The currency traders sold the Yen, FXY, today, to 121.91, as the bond vigilantes called the Interest rate on the US Government Bond, $TYX, higher, to 4.053%, which caused the longer out maturity US Government debt, that is, the 10 to 20 Year US Government Bonds, TLT, and the Zeroes, ZROZ, to fall sharply lower.

    Fan Yang of FXTimes writes that the EUR/JPY pair exploded, after breaking out of a declining channel yesterday. After a quick throwback in the 4H chart that failed to break below the 50 SMA, the market shot up breaking the 114.00 level and 61.8% retracement (a strong level of resistance)

    The Euro, FXE, rose 0.67%, to close at 140.70 at the top of a broadening top pattern, suggesting that it has maxed out.

    Bonds, BND, rose to a new high and manifested a massive questioning harami, suggesting that Total Bonds has topped out.

    Today, November 3, 2010, was a rally high for the worlds stock and bond traders as they celebrated the flow of investment liquidity from the US Central Bank and carry trade investing.

    China small caps, HAO, was one of the celebrators, rising 1.0% to close at 122.19. And, Poland, EPOL, a favorite for yen carry traders, rose 1.2%. And mortgage finance, KME, got the investment cool aid as well, rising 2.7%

    Today was a disaster for those invested long in US Sovereign debt, TLT as the bond vigilantes called the longer out rate higher, as the US Central Banks QE 2 constitutes monetization of debt.

    The spigot of investment liquidity from the US Central bank has turned toxic, as it is now monetizing debt.

    And the spigot of investment liquidity from carry trade investing will be turned off as carry traders sell off the major currencies, DBV, and emerging currencies, CEW, given that they are over-bought.

  4. The US Gov’t simply cannot monetize like this forever. As QE2 and soon enough QE3 arrives, the value of the USD will take hit after hit, especially versus commodities. We’ll see $3.50/gal next year in the US and perhaps $4.00/gal in 2012. It won’t be a temporary thing either, and the effects will cripple consumer spending and unsecured debt repayments. There will be no recovery; you cannot simply print trillions and call it prosperity. As for predicting Bernanke’s actions, I’ll take a minute to toot my own horn here:


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