QE3 – Kames Capital’s Sandra Holdsworth asks: Is it different this time?

Sandra Holdsworth, fixed income manager at Kames Capital, looks to what is different in the latest round of quantitative easing announced by the Federal Reserve.

Last week, modern monetary policymaking entered a new phase. Following similar actions by the ECB, the US Federal Reserve entered into a policy that promised unlimited but conditional commitment in its efforts to get the monetary transmission mechanism working and therefore aid economic recovery.

The Federal Open Market Committee announced a third programme of quantitative easing, which involves spending $40bn per month to buy government agency-backed, mortgage backed securities. This is to run in parallel with the existing maturity extension and reinvestment programme (‘Operation Twist’), which will continue to the end of the year. The QE3 programme has no end date or size limitation; it will continue until the FOMC believes it’s no longer required. The aim of the policy as stated by the FOMC is that: “these actions should put downward pressure on long-term interest rates, support mortgage markets and help to make broader financial markets more accommodative.” With regard to interest rates, the FOMC anticipates that the current target level for the Federal Funds rate at 0 to 0.25% will be warranted until mid-2015.

So, we know what they are going to do and why they are doing it. But is this any different from previous QE programmes that have boosted risk asset markets whilst they have been in operation, but led to more subdued performance once they have ended?

An obvious difference is that this programme has no end date; there is no limit to the size and length of the commitment. Not only that, the FOMC could do more – further on in its statement it says: “If the outlook for the labour market does not improve substantially, the committee will continue its purchases of agency mortgage backed securities, undertake additional asset purchases and employ other policy tools as appropriate until such improvement is achieved in a context of price stability.” So there is the conditionality – unlimited easing until employment picks up. In the press conference following the statement, chairman Bernanke was careful not to mention precise targets.

Many commentators have always expected the FOMC to do more if the US economy faltered but this time the FOMC has acted before activity slowed, before asset markets weakened and this time there is no end date for the easing of policy. For risky markets this is extremely supportive. For bond markets, the removal of the risk premium may lead to higher yields, especially in longer-dated maturities in the short-term. But the guidance regarding short-term interest rates plus the ongoing buying of Treasuries and mortgage backed securities will lend substantial support, fulfilling the FOMC’s aim of keeping long-term interest rates low.

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