The Fed is looking into a new type of quantitative easing that will try to jump-start the economy without jumpstarting inflation. But will it work?
It was November 2010 when the Fed launched its last quantitative easing program, which we lovingly nicknamed QE2. It fell on mixed reviews – mainly dependent upon how you like your monetary policy.
We all know the pros and cons of easing. You get elevated asset prices with the fear of inflation. But what if you could keep your cake and eat it, too? What if you could keep this fledgling recovery going without driving up the price of oil?
Well Mr. Bernanke believes he can do just that.
“Sterilized” Quantitative Easing
The Fed is looking into a new type of quantitative easing that will try to jump-start the economy without jumpstarting inflation. Analysts said the new approach would allow the Fed to move despite high oil prices.
And here’s the plan. The Fed would make new money to buy long-term mortgage or Treasury bonds, but in essence tie up that money by borrowing it back for short periods of time at low rates. This particular new twist in QE has been dubbed “sterilized” quantitative easing and it would use reverse-repurchase agreements to keep the money from flowing to bank reserves.
QE will be delivered via purchases of mortgage backed securities (MBS) and Treasuries, with a bias for the former, and will be sterilized in order to appease inflation hawks and critics, the Nomura Group has stated.
Ben Bernanke has hinted around that more easing is around the corner if needed. Remember, the Fed’s outlook on the recovery is a little less rosy than everyone else’s.
With housing prices still looking for a bottom, meager job growth, record-high oil prices, and the probable resurgence of the European sovereign debt crisis in the near future, Bernanke must deliver an “insurance ease” to make sure the economy maintains its “escape velocity,” Nomura’s analysts argue. In other words, the Fed needs to “pump the economy to a high enough level to weather the […] storms that sill lie ahead for the nation.”
When We Should Expect QE 2.0
Along with Nomura, Goldman Sachs’ Jan Hatzius believes the Fed will deliver additional quantitative easing over the next three to six months.
The Fed has been meddling in the bond markets consistently over the past four years, and would be scared of what would happen if they did an immediate full-scale evacuation from them.
The Fed’s latest venture called Operation Twist – where they sold short-term assets and bought longer-termed securities – ends this June.
Sterilization, which will occur via a small extension of the Twist, term deposits and reverse repos, will “keep the hawks at bay because a slight rise in front-end rates should support the dollar and reduce oil inflation,” explained the analysts.
Under current circumstances, where growth is picking up but the recovery remains fragile, the Fed will prefer “a more nuanced and targeted sterilized-easing approach, which has a lower impact on commodity prices and helps appease inflation hawks in the FOMC,” concluded Nomura’s analysts.
QE3, then, is around the corner.
Good Investing,
Jason Jenkins
Article by Investment U
