Suspicions linger in Bernanke Fed’s latest move, says Schroders’ Keith Wade

Schroders’ chief conomist, Keith Wade, says the massive commitment to QE3 by the US Federal Reserve suggests a political move and possibly a policy to inflate away debt.

Ben Bernanke confirmed his reputation as the world’s most dovish central banker by launching a third round of Quantitative Easing, this time with an open commitment to keep going until the labour market has significantly improved. The Fed will now buy $40 bn of agency Mortgage backed securities per month, operation Twist continues and the central bank has extended its commitment to keep rates low until the middle of 2015.

Whilst there was some debate about how much the Fed would announce, this is at the top end of expectations. It marks a more decisive step in monetary policy which will set the tone for the rest of Bernanke’s term as chair of the Fed until 2014. It might be seen as Bernanke’s message to the politicians ahead of the Presidential election, where a Republican victory would make the environment for such action more difficult. Whether Bernanke is swayed by such considerations is debatable. Nonetheless, the political action he will be concerned about is the need for a new President and Congress to negotiate the fiscal cliff which threatens to derail the economy in 2013.

Compared to previous rounds of QE this one is different as the focus is on the real economy and employment, rather than fears of deflation. It is also open ended and so draws comparison with the ECB’s unlimited commitment to buying sovereign bonds.

Markets love it and risk assets have rallied on the news. The search for yield will become even more acute and investors will be driven into riskier assets in the search for income.

Will it make much difference to the economy? Stronger markets will boost wealth and confidence. However, there is growing disenchantment with QE as many question how simply printing money can affect decisions to invest in the real economy. Much of the QE so far has ended up trapped in the banking system rather than being lent.

The dollar has weakened on the announcement and will help the US and much of Asia, but currency moves are a zero sum game so will only make life more difficult for others, in the case of the eurozone. The suspicion that the Federal Reserve is trying to inflate its way out of the debt crisis remains and it is notable that long bond yields have risen since the announcement.

 

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