Tag: QE3

 As they meet today the Federal Reserve’s governors face a dilemma; with unemployment creeping lower while inflation rises, can they justify a third round of stimulative quantitative easing? Gavyn Davies, chairman of Fulcrum Asset Management, explains to Long View columnist John Authers that while the Fed is keen for QE3, it needs to bring inflation more under control first.  (5m 27sec)

The Fed decision was fairly close to what was anticipated in this earlier blog – all “twist” and no “shout”. However, on balance, the statement was slightly more dovish than I expected. Concerns about downside risks to economic activity were at least as great as in last month’s FOMC statement, with new downside risks from financial strains being specifically mentioned, and this has swayed the majority of the committee to introduce a slightly more aggressive operation “twist” than expected. Inflation concerns, while marginally greater than in the August FOMC statement, are clearly insufficient to impress the committee, which remains biased towards further easing even after today’s announcement.

Opinion is sharply divided about what the Fed intended to signal in the statement issued on Tuesday. Some have seen the statement as very dovish, because it said that the Fed intended to leave short rates at “exceptionally low levels” until mid 2013 – the first time that a specific date of this sort has ever been set by the FOMC.

Others, however, concluded that the statement contained nothing really new, since the markets had already assumed that short rates would be close to zero for the next two years. Furthermore, the fact that there were three dissents from the majority decision has led some to deduce that the further large step to more quantitative easing (QE3) is still a long way off. On this view, nothing really changed.

One way of trying to assess whether the Fed eased policy on Tuesday is to use the Taylor Rule, which translates economic conditions into the “appropriate” setting for monetary policy.

Ben Bernanke

Ben Bernanke. Image by EPA.

The financial markets seem determined to interpret today’s statement by the Fed chairman in a dovish light, but a careful reading of his words does not support that point of view. True, Mr Bernanke outlined the possible ways in which monetary policy might be eased further if recent economic weakness should prove more persistent than expected. But he gave equal weight to the possibility that “the economy could evolve in a way that would warrant less-accommodative policy”.

There was no hint in the text about which of these outcomes he considered the more likely. We already knew from yesterday’s FOMC minutes for the June meeting that the committee is split about the likely evolution of policy, and we were waiting to see today whether the chairman would throw his weight behind either the doves or the hawks. He failed to do either.

The US employment numbers for May seemed to surprise the markets, but in fact they confirmed what we already knew from a string of earlier data releases, which is that the economy has slowed very markedly in recent months. The debate now is whether this slowdown has been triggered mainly by transitory factors – the fallout from the Japanese earthquake, stormy weather, and a spike in gasoline prices above $4/gallon – or whether it reflects a more fundamental malaise in the economic recovery.

The equity markets have remained fairly upbeat about this, and most economists are still strongly of the view that this is just another mid-cycle slowdown of the sort which occurred last year. This still seems to be the most probable outcome (as I will argue here on Sunday). But what if this optimism is wrong? Is there a Plan B?

Gavyn Davies

on macroeconomics

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A blog on macroeconomics, economic policymaking and the financial markets. Gavyn usually writes about a key topic of the week on Sunday.

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Gavyn Davies is a macroeconomist who is now chairman of Fulcrum Asset Management and co-founder of Prisma Capital Partners. He was the head of the global economics department at Goldman Sachs from 1987-2001, and was chairman of the BBC from 2001-2004.

He has also served as an economic policy adviser in No 10 Downing Street, an external adviser to the British Treasury, and as a visiting professor at the London School of Economics.

Gavyn Davies is an active investor and may have financial interests and holdings in any of the topics about which he writes. The views expressed are solely those of Mr Davies and in no way reflect the views of Prisma Capital Partners LP, Fulcrum Asset Management LLP, their respective affiliates or representatives. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations. Readers are urged to seek professional advice before making any investments.

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