QE2

Robin Harding

Goldman Sachs is still the Fed’s favourite counterparty for buying and selling Treasuries – or at least it was in the first quarter of 2011. The data comes out two years in arrears and we are now at the period when $600bn of QE2 purchases were in progress.

Goldman got twice as much of that business as anybody else, which is mildly embarrassing for the New York Fed, but reflects the pecking order in the Treasury market. If you know what happened to Citi’s business during that period then please explain in comments. 

Chris Giles

Martin Weale’s speech today shows how far the policy debate has shifted at the Bank of England. As recently as early July, this external member of the monetary policy committee was voting for higher interest rates. Now he is openly talking about restarting quantitative easing.

Mr Weale should certainly be praised for being as good as his words. In March he said he was perfectly happy to change his mind if the facts changed and he has done so. No longer voting for a rate rise does not indicate a previous error of judgment, only that circumstances have changed.

From his speech today, Mr Weale, one of the more hawkish MPC members, now clearly thinks that UK QE2 might be necessary and he believes it would work. 

Robin Harding

Charts often circulate that show the size of the Fed’s balance sheet alongside movements in commodity or stock prices – they are used to make a prima facie case that QE2 inflated commodity prices.

Here is a not-very-good version but the best I could manage with FRED (note to St Louis – it’d be lovely to have the GSCI index plus all the numbers from H.4.1). Another one you often see is commodity price movements on the days when the Fed actually conducted QE2 buying. 

Robin Harding

The New York Fed has announced its schedule for the final purchases under the $600bn programme that began last November. After that, the only purchases will be reinvestments of maturing MBS, which are now down to $12bn a month.

UPDATE 

Many investors fear that the Fed’s impending exit from QE2 will have a very damaging effect on the financial markets. Whether they are right will depend on the nature of the exit, and its impact on bond yields. An end to the Fed’s programme of bond purchases, without any increase in short rates, is unlikely to be sufficient, on its own, to trigger a major bear market in bonds and equities. But an end to the Fed’s “extended period” language on interest rates would be a much greater threat. I still do not expect this to happen soon.

Recently, the Fed has purchased 60-70 per cent of all the bonds which have been issued to finance the US budget deficit. Some influential analysts (Bill Gross of Pimco among them) argue that bond yields will rise sharply when the Fed withdraws its life support from the bond market. But there are some powerful advocates, including the Fed chairman himself, for an entirely contrary point of view. Ben Bernanke told Congress in February that he did  not expect to see “a big impact” on bond yields when the Fed ended its asset purchases.

The Fed has hardened its thinking on this question in the past couple of years. It has  decided that QE reduces bond yields via its effect on the total stock of outstanding bonds, and not via its impact on the flow of bonds purchased in any given period. If this is the case, then

 

Robin Harding

I’ve written here before that one possibility under discussion at the Fed is tapering off its $600bn QE2 asset purchases in order to minimise market disruption when they end.

Today, president James Bullard of the St Louis Fed raised the option of tapering so total purchases when the programme stops at the end of June are less than $600bn.

“The natural debate now is whether to complete the program or to taper off to a somewhat lower level of assets”

Mr Bullard told reporters after an interesting speech that he would favour a small reduction in the programme at the next meeting in March to reflect the better economic outlook.

Several market commentators have also put forward a slightly different version of a taper: 

James Bullard delivered an interesting, chart-rich speech on inflation, QE2 and global output gaps on Thursday. The now non-voting St Louis Fed President was a strong advocate of QE2 as a way to reverse alleged deflationary pressures. Bullard hits back at those claiming the Fed is importing inflation, saying — as Ben Bernanke did in Paris on Friday — that some “countries are choosing to import US monetary policy to some extent”.

But — and now we get to the really interesting bit of the presentation — Bullard does wonder whether the US should consider ‘the global output gap’. As John Kemp pointed out in his column on Thursday morning:

It is the first time a senior official at the U.S. central bank has acknowledged global capacity issues rather than a narrow focus on U.S. unemployment and capacity utilisation might give a better indication of where inflation is headed.

Bullard uses the following chart to suggest that “the global ouput gap is probably much narrower or even positive”:

 

Robin Harding

In its statement today the FOMC removed language about buying assets at a pace of $75bn per month, causing a bit of a stir in the markets.

December 15th:

In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.

January 26th:

In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.

There are a few ways that you can read that: 

Robin Harding

I agree with my colleagues at FT Alphaville that “counterfactuals are inherently tricky” but I don’t think they quite get to the heart of the case that you could mount against the new estimates of the effects of Fed stimulus programmes that Janet Yellen cited in her speech on Saturday.

Those estimates are that inflation is one percentage point higher than it would be had the Fed made no asset purchases and employment will be 3m higher than it would have been in 2012.

It’s important to note that David Reifschneider, senior associate director of the FRB’s department of research and statistics, and John Williams, once of that parish and now research director of the San Francisco Fed, are co-authors of the paper. That means this is as close to an official ‘Fed view’ as we are ever likely to get on the effectiveness of QE. 

Robin Harding

The NY Fed has announced its tentative schedule for bond purchases through to mid-January. The Desk plans to buy $105bn in Treasury securities. Two observations:

(1) It’s a little less than expected. The $75bn related to QE2 is unchanged, but the schedule includes only $30bn for reinvestment of mortgage prepayments, less than the $35bn a month predicted as of the beginning of November. That suggests the rise in 10-year rates is already affecting the NY Fed’s forecast of mortgage prepayments. I’m trying to find out a bit more about this but with an FOMC meeting next week I doubt the FRBNY will be especially forthcoming.