The financial markets are giddy today based on what they think the FED said on their last meeting. Pretty much every news agency reads the FED minutes as a hint that QE3 is in the cards. I don’t. The minutes say no such thing. Yes there is a discussion were many or several see merits of further asset purchases while many or several see risks. There is no indication that the MPC members will go either way. Here is what the minutes said:
“Participants also exchanged views on the likely benefits and costs of a new large-scale asset purchase program. Many participants expected that such a program could provide additional support for the economic recovery both by putting downward pressure on longer-term interest rates and by contributing to easier financial conditions more broadly. In addition, some participants noted that a new program might boost business and consumer confidence and reinforce the Committee’s commitment to making sustained progress toward its mandated objectives. Participants also discussed the merits of purchases of Treasury securities relative to agency MBS. However, others questioned the possible efficacy of such a program under present circumstances, and a couple suggested that the effects on economic activity might be transitory. In reviewing the costs that such a program might entail, some participants expressed concerns about the effects of additional asset purchases on trading conditions in markets related to Treasury securities and agency MBS, but others agreed with the staff’s analysis showing substantial capacity for additional purchases without disrupting market functioning. Several worried that additional purchases might alter the process of normalizing the Federal Reserve’s balance sheet when the time came to begin removing accommodation. A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations. Many participants indicated that any new purchase program should be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the Committee’s assessment of the efficacy and costs of the program.”
Such a discussion is nothing new for the MPC members. Here is what they said at the last meeting on June 19th-20th:”
Most participants viewed the risks to their inflation outlook as being roughly balanced. Some participants, however, saw persistent slack in resource utilization as weighting the risks to the outlook for inflation to the downside. In contrast, a few saw inflation risks as tilted to the upside; they generally were skeptical of models that rely on economic slack to forecast inflation and were concerned that maintaining the current highly accommodative stance of monetary policy over the medium run risked eroding the stability of inflation expectations, with a couple noting that large long-run fiscal imbalances also posed a risk.”
“Many FOMC participants judged that overall financial conditions had become somewhat less supportive of growth in demand for goods and services. Investors’ concerns about the sovereign debt and banking situation in the euro area reportedly intensified during the intermeeting period, leading to higher risk spreads and lower prices for riskier assets including equities and to broad-based appreciation of the U.S. dollar on foreign exchange markets. In contrast, a few participants observed that the marked drop in yields on longer-term U.S. Treasury securities could provide some impetus to growth. Focusing more narrowly on the banking sector in the United States, it was noted that measures of credit quality for bank loans generally had continued to improve, that bank capital levels were quite high, and that banks had ample liquidity. Consumer and business loans were increasing, although credit standards remained tight and commercial and residential real estate lending were relatively weak. A few participants indicated that they were seeing signs that very low interest rates might be inducing some investors to take on imprudent risks in the search for higher nominal returns. Participants discussed the risk that strains in global financial markets and pressures on European financial institutions could worsen and spill over to parts of the domestic financial sector, and some noted the importance of undertaking adequate preparations to address such spillovers if they were to occur; it also was recognized that investor sentiment could improve and strains in global markets might ease. Several participants commented that it would be desirable to explore the possibility of developing new tools to promote more-accommodative financial conditions and thereby support a stronger economic recovery.”
Same kind of discussion. In fact just 6 weeks before they were seeing signs that low interest rates are inducing some to take unnecessary risks.
To me the main reason brought forward by supporters among the MPC members of QE3, lower long term rates, does not make sense and it will not help. Long term rates are as low as they can be. The 10 yr US treasury is at 1.7%. Where would it go with more QE3? At 1%, 0.5% or zero? does it really make a difference for the corporations that want to invest?
If the economy is not roaring at 1.7% rates for 10years I doubt that it will at 1% or even 0. But this is not how financial markets look at QE3. And that is why they try to push the FED into one more “hit”. For financial markets is just more cash for “clunkers” only that in this case we have cash for stocks.
In the case of cash for “clunkers” we saw the auto demand fall when the programs ended. As governments did not promise any similar programs there was not more demand.
In the case of Financial Markets we are dealing with just wishful thinking. Also, FED deserves some of the blame. It never said that QE3 is off the table. In this environment markets are just hoping for the next “hit” and interpret any comment related to the long term asset purchase as hint that “it is in the cards”.
This game can go on for a while but at some point markets have to “wean” themselves from the government money. The Fed could have made it clearer but I guess it does not believe in a clean break. It might be right. However, all I see the FED doing is just slowly giving the markets the confidence that they will be fine without QE3. In my view we will not see this from the FED in this recession. The next big move is taking cash out (I am not sure when yet).
P.S.There are two ways to deal with a situation like this. Professor Dan Arierly in his book Predictably Irrational thinks that it is better to get rid of a big problem slowly.
On the other hand Seinfeld believes in the clean brake solution (the frist minute):