FOMC Launches Open-Ended Quantitative Easing Program (QE3)

As it turns out, the words "fairly soon" referring to the timing of further stimulus in last month's Fed minutes meant September the 13th. The Fed indeed delivered a double dose of extra monetary policy stimulus today while keeping rates unchanged at zero.

Firstly, the FOMC decided to extend by six months "at least through mid-2015", the period over which it expects to maintain the target range at 0-0.25%. Secondly, and perhaps more eagerly anticipated by markets, the FOMC decided to embark on a new asset purchase program i.e. the long awaited QE3. The Fed will purchase agency MBS at a pace of $40 bn/month without specifying an end-date to the program. In other words, that’s an open-ended quantitative easing program. Operation Twist will continue as announced in June, meaning that, together with today's new measures, the holdings of longterm securities will grow by $85 bn/month through the rest of the year.

The Fed made clear that if the labour market doesn't improve substantially, it will continue its purchases of MBS, undertake additional asset purchases and employ other policy tools. Supporting its decision today, the Fed explained that it is concerned that, without further stimulus, economic growth may not be strong enough to generate sustained improvement in labour market conditions. Crucially, the Fed made clear that the highly accommodative stance of monetary policy will remain appropriate for a considerable time even after the economic recovery strengthens.

Following its dovish statement and the accompanying double dose of extra stimulus, the Fed released its latest economic projections which showed an expected downgrade for this year, although there was a marginal upgrade to the two subsequent years. The central tendency forecast for GDP growth (Q4/Q4) is now 1.7-2.0% in 2012 (versus 1.9- 2.4% previously). The estimate is 2.5-3.0% for 2013 (versus is 2.2-2.8% previously) and 3.0-3.8% for 2014 (3.0-3.5% previously). The projection for the unemployment rate is roughly unchanged for this year and next: 8.0-8.2% for 2012 (same as last June), 7.6-7.9% for 2013 (7.5-8.0% previously), but has been trimmed for 2014 to 6.7-7.3% (7.0-7.7% previously). Interestingly, inflation forecasts were upgraded a bit, particularly the PCE deflator for this year (perhaps to account for more expensive gasoline), although those remained close to the Fed's 2% target through the projection
horizon. While there's no information about voting and non-voting members' views (except perhaps for Jeff Lacker who dissented on both of the new stimulus measures unveiled today), the FOMC presented information about how participants feel about the pace of policy firming going forward. Thirteen members see rates remaining at or below 1.50% in 2015. FOMC members continue to view that the fed funds rate should be in the 3-4.5% range over the longer run, with the majority seeing the fed funds at 4% or above.

In the press conference, while Chairman Bernanke acknowledged that monetary policy is no panacea to the ongoing economic woes, he reiterated that Fed policies could still have some positive impact, either via explicit measures like today and/or via communication. He pointed out that the objective of the MBS is to quicken the economic recovery, particularly in the housing market, and also through a positive wealth effect (both housing and stock market). The Chairman restated that the Fed’s policies could not offset the negative impacts of the upcoming fiscal cliff and urged Congress to address that threat as well as the long term sustainability of fiscal policy.

The Chairman pointed out that while in the past, Fed policy tended to be conditional on economic developments, this time it was more explicit with pledges to continue to buy MBS and other assets if the labour market does not improve “substantially”. According to the Chairman, the objective was to convey the message that the Fed is commitment to achieve its dual mandate and hence provide a boost to confidence. Chairman Bernanke reiterated during the Q&A that the accommodative stance of monetary policy will remain appropriate for a considerable time even after the economic recovery strengthens, reassuring investors that there won’t be a premature withdrawal of stimulus.

Bottom line:
The Fed has turned quite dovish based on the statement and the information about the participants' views on the appropriate pace of policy firming. The downgrades for this year are consistent with the extra stimulus provided today. The twin measures and the ongoing Operation Twist, should help lower long yields, and perhaps extend the current “risk on” environment. That said, the impacts on near term US growth will be minimal at best, and won't offset the negative impacts from the upcoming fiscal cliff if the latter materializes. While the Chairman refrained from commenting on the currency, it’s clear that the US$ depreciation resulting from the Fed's looser policies should maintain support to an export sector that has grown in importance in recent years.