The Fed, Quantitative Easing and Its Effects on the Economy
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Since September 2012, the Federal Reserve has been purchasing $85 billion of fixed income securities per month. The aim has been to support the economic recovery by placing downward pressure on interest rates and risk premia. The large flow of liquidity is also seen as aiding stock market valuations.
Although arguably helpful in the short term, quantitative easing is not a sustainable policy for the long term. Most financial market participants expected the Federal Reserve to announce the start of a gradual reduction in the monthly pace of bond purchases during their September 2013 meeting. In response, although the Fed tried to communicate that a reduction of the pace of bond purchases would not signal a rise in the Federal Funds rate, the yield on the 10-year treasury rose about 1.25% from the first hints at tapering bond purchases until a few weeks before the September meeting. The rise in Treasury rates translated in a similar rise in the 30-year fixed-rate mortgage, which had a very noticeable impact on refis. Home purchases also slowed somewhat. Since the Federal Reserve sees the housing market as the cornerstone of a durable recovery, it decided to continue purchasing bonds until it could be sure about the strength of the recovery.
Now, in November of 2013, the Federal Reserve is in a tough spot: it wants to slow bond purchases to prevent financial instability to build up (bubbles) but at the same time is uncertain about the ability of the recovery to sustain higher interest rates.
To read more about the Fed’s current quandary, check out the Bloomberg article “Fed Ponders How to Temper Tapering Without Rate Increase” by Caroline Salas Gage.
Let’s hope that Janet Yellen will be more successful than Bernanke in effectively communicating the Federal Reserve's monetary policy.
Rogier Kamerling, Treasurer
November 21, 2013