Fed Embarks on QEII
The Federal Reserve made it official: it is embarking on another round of quantitative easing.  To be specific, it will buy an additional $600 billion in long-term Treasury securities from now through the middle of 2011 ($75 billion per month).

This is on top of its commitment to reinvest (into long-term Treasury securities) principal payments on its pre-existing portfolio of mortgage securities.  In addition, the Fed made it clear that although the program of purchasing more securities will start with an end date in mind (mid-2011), the Fed will regularly assess whether to lengthen and/or expand the program based on the nature of incoming economic and financial data.

As everyone expected, the Federal Reserve made no direct changes to the stance of monetary policy today, leaving the target range for the federal funds rate at 0% to 0.25%.  The Fed also made no changes to its commitment to keep the funds rate at this level for an "extended period."  Some analysts had suggested, given the mid-year deceleration of economic growth, that the Fed would somehow make this commitment even more iron-clad.

However, in addition to another round of quantitative easing, the Fed did make some notable changes to its statement, generally signaling more concern about the economic recovery.  First, the Fed now says that information "confirms," rather than "indicates," economic weakness.  Second, the Fed says economic progress has been "disappointingly slow" rather than suggesting progress will be "modest in the near term."  On the brighter side, the Fed omitted a prior reference to a contraction in bank lending.

Once again, Kansas City Fed President Thomas Hoenig was the only dissent to the Fed's policy changes. 

We believe the Fed's new round of quantitative easing will have little to no impact on the larger economy.  Banks already hold roughly $1 trillion in excess reserves.  Adding to this pile of reserves will not influence the desire of financial institutions to lend, nor will it lead to any near-term increase in the supply of currency in circulation.  All it will do is sit idle on the liability side of the Fed's balance sheet and on the asset side for the banks.

More importantly, the economy is already accelerating.  The four-week moving average of new claims for unemployment insurance is declining again.  Wages and total hours worked are rising in the private sector.  Auto sales are the highest in more than two years (except for cash-for-clunkers).  Businesses are consistently increasing investment in equipment.  Given these trends and what we think will be an offset to anomalies in trade data the past two quarters, we believe real GDP growth will come in at close to a 5% annual rate in the current quarter.

In other words, Hoening is right and the Fed will eventually come to regret its latest decision.

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Posted on Wednesday, November 3, 2010 @ 3:19 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.