Fed Sets Sail on QE3
They did it. The Federal Reserve today announced a third round of quantitative easing, making an open-ended commitment to buy additional mortgage-backed securities at a pace of $40 billion per month. The Fed said it also will "closely monitor" the economy and financial markets and continue these purchases and possibly expand them until they see substantial improvement in the outlook for the labor market.

An open-ended program means QE3 will last as long as the Fed wants and we cannot be sure when it will end. However, at $40 billion per month, it is smaller on a monthly basis than the last round of quantitative easing, which was about $70 billion per month.

Besides another round of quantitative easing, the Fed also changed its time frame before it expects to change the near-zero short-term federal funds rate to mid-2015 from a previous projection of late-2014. In conjunction with this timing shift, the Fed made it clear that it now thinks it will maintain near-zero rates for a "considerable time" after any strengthening in the economic recovery. Based on the new economic projections from the Fed, it appears to be saying that the federal funds rate will remain where it is until the unemployment rate is at or very close to 6%.

In the context of these major policy decisions, the Fed also made some changes to the language of its statement. The Fed said the economy had "expanded at a moderate pace," rather than "decelerated," acknowledged improvements in household spending, but also noticed deceleration in the growth of business investment.

The Fed's explanation for QE3 was that without it economic growth might not be strong enough to generate sustained improvement in the labor market. In other words, the Fed is now focused mainly on the labor market as a gauge of the performance of the underlying economy.

The one minor point in favor of those concerned about inflation was that the Fed was explicit about saying it had a 2% inflation objective. Of course, for the time being, that objective appears subordinate to the goal of a faster improvement in the labor market. And in his press conference the Chairman admitted that he would accept higher inflation temporarily.

Once again, the lone dissent from the Fed's statement was from Richmond Fed President Jeffrey Lacker, who opposed both QE3 and the description of a time frame before the Fed would raise rates.

Our bottom line remains that QE3 will simply add to the already enormous excess reserves in the bank system, not deal with the underlying causes of economic weakness, including the growth in government spending, excessive regulation, and expectations of higher future tax rates. QE3 will not add anything to economic growth and, as long as banks are reluctant to lend aggressively, not cause any hyper-inflation either.

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Posted on Thursday, September 13, 2012 @ 3:31 PM

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.