U.S. Federal Reserve Launches QE3!


Location: Toronto
Date: 2012-09-14

  • Coming out of the conclusion of today’s Federal Open Market Committee (FOMC) meeting, the Federal Reserve opted to provide further accommodation to the system aggressively by increasing purchases of mortgage-backed securities (MBS), i.e., QE3. It also extended its forward guidance on maintenance of the current low range of fed funds of 0% to 0.25% until mid-2015.
  • The aggressive nature of the easing was further reinforced by an open-ended commitment to maintain the MBS purchases at $40 billion per month until there was a substantial improvement in labour markets. This commitment is over and above the current policy of reinvesting principal repayments of its existing MBS holdings. It further added that the absence of this desired improvement in labour markets would prompt other asset purchases along with “other policy tools.”
  • The FOMC statement indicated that the so called “Operation Twist” would continue until the end of this year as originally announced in June.
  • Further policy accommodation was justified because of concern among FOMC members that “without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions.”

 

The question mark going into this week’s Federal Open Market Committee (FOMC) was not so much whether a further ease would be introduced but rather how this accommodation would be implemented. This consensus view of the need for more stimulus was solidified following the disappointing August payroll employment report, which indicated a greater than expected slowing in employment growth. Prior to the release of this data, Fed Chairman Bernanke had commented that the “stagnation of the labour market in particular is a grave concern.” The August data likely heightened those concerns thus prompting the Fed to respond today by announcing additional stimulus to the system.

How will the Fed provide this additional easing? With the range for fed funds already at it lower bound of 0% to 0.25%, interest rate cuts were clearly not an option. What was a possibility with respect to fed funds was extending the forward guidance as to how long these “highly accommodative” rates would be maintained. A second option was to announce further asset purchases that could entail another round of quantitative easing. Today’s FOMC statement indicated that both options will be implemented.

The most aggressive action introduced was the announcement that there would be increased purchases of mortgage-backed securities (MBS) at a pace of $40 billion per month. In other words, the Fed is embarking on QE3. The statement went on to say that “if the outlook for the labour market does not improve substantially, the Committee will continue to purchase agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.” The Fed is making an open-ended commitment to provide liquidity to the system aggressively even beyond the quantitative easing announced today, until the lethargy in the economy is reversed and the unemployment rate is put on a sustained downward track.

As was widely expected, the forward guidance was extended with the FOMC anticipating that exceptionally low levels for the fed funds rates likely being warranted “through mid-2015.”

Other policy actions referred to in the statement were the continuation of existing programs. Specifically, Operation Twist, i.e., the selling of short-term notes to buy long-term bonds, would continue until the end of the year as announced in June. As well, the Fed announced that it would continue to re-invest “principal payments from its holding of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.”

The justification of this additional aggressive policy stimulus was attributed to the FOMC members becoming concerned that “without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions.”

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.

 

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