Forget Freddie Krueger. QE3 is scarier

On 6-22-11, the Fed left the fed funds target at a range of 0.0% to 0.25% and continued to say they will hold rates at “exceptionally low levels” for an “extended period.” At this meeting, Federal Reserve officials made the following revisions to their economic forecasts for both 2011 and 2012: lower economic growth, higher
unemployment, and higher core inflation. This brings the Fed’s forecasts more in line with private economists. The Fed’s post-meeting statement said, “The slower pace of the recovery reflects in part factors that are likely to be temporary (our emphasis), including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan” The day after the Fed meeting the WSJ wrote, “Federal Reserve officials see the US economy settling into a disappointingly weak recovery this year and next, and say they have done all they are prepared to do to spur growth for now.” However, in his post-meeting press conference, Bernanke actually did leave the door open to a possible QE3 or other Fed action if the economy performs much worse than expected when he said the Fed would be “prepared to take additional action, obviously, if conditions warranted.” Following today’s end of the Fed’s $600b QE2 Treasury purchase program, the Fed’s balance sheet is currently $2.8 trillion, or four times its pre-crisis level. About $900b of their balance sheet is currently in Agency Passthroughs.


Generally speaking, the Fed’s broad goals for QE2 were to lower long-term Treasury rates, avoid deflation, and improve financial conditions in order to boost economic growth and lower the unemployment rate. In speeches last fall, Fed officials publicly said they wanted to boost stock prices in order for the so-called
wealth-effect to boost consumer spending. On a much more technical level, the Fed was trying to boost inflation expectations in order to avoid potential deflation. In general, inflation expectations have risen by about 100BPs since Bernanke first hinted at QE2 on 8-27-10. Inflation expectations over the next ten years
(10-year Treasury yield - 10-year TIPS yield) have risen about 100BPs since August-2010 to 2.5% currently.

Source: Brick and Associates