Fed Moving Toward “QE3”

The Federal Reserve’s answer to woeful economic performance since the onset of the recession in 2008 is to print more money to buy up U.S. government debt in a move described as “quantitative easing.” Now it appears that despite Chairman Ben Bernanke’s stance that the Fed was through with this practice following the end of QE2, there will be a need for another round of “easing” to keep stocks from plummeting as unemployment rises. The theory is that the stimulus encourages borrowing and spending by keeping interest rates lower while buying more time for a turnaround without default, but without sound policy decisions being made in the interim it just amounts to a delay of the inevitable. For more on this continue reading the following article from Tim Iacono.

It would appear that the magic elixir of a two-year pledge for freakishly low interest rates from the Federal Reserve has an effective life of only about 18 hours since, after yesterday’s remarkable 400+ point move higher for the Dow Jones Industrial Average, that gain has been reversed in trading today, markets effectively telling Ben Bernanke and the rest of the staff at the central bank, “What else you got?”

Recall that, yesterday, the Fed fired off the first of a possible three shots that could be seen prior to what some analysts predict will be another $1 trillion or so in outright money printing to buy government debt or some other asset that, if all goes well, would goose the markets for another six months or so, just like it did last year.

After the low rate promise yesterday, what’s likely to be heard next from the Fed is: a) they intend to lower the interest paid on excess reserves to compel banks to lend a little more, or b) they’re going to fiddle with the two trillion dollars in assets they’ve purchased in recent years to somehow convince somebody to do something that would somehow right the quickly sinking ship.

Neither of these steps are likely to have a more lasting impact than yesterday’s move, so, what we’re really looking at here is either the Fed can embark on QE3 and, if all goes well, boost asset prices until mid-2012, or they can sit on their hands and watch the stock market fall further while the jobless rate rises.

Based on the three dissenting votes for yesterday’s action, any subsequent moves by the Fed will be met with similar disapproval by some voting members, however, that’s not likely to stop the doves from printing up another trillion dollars or so for the greater good.

After yesterday’s baby step in that direction, Goldman Sachs said today that QE3 sometime later this year or in early-2012 is now likely and, based on how markets are moving today, it’s hard to disagree with that view, the only variable seeming to be the size and the timing.

With the Dow now closing in on bear market territory while other stock indexes have already breached that level, you’d think that it won’t take too much more of this for the Fed to act. Moreover, the only way that we’ll likely make it to the Jackson Hole group therapy session in two weeks (where a major policy initiative could be announced) without an even more severe breakdown in equity markets is if all the Fed doves start making speeches about QE3 – when, how much, and how they see this as the best of a handful of policy options.

They’re probably already working on those speeches…

This blog post was republished with permission from Tim Iacono.