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Unconventional Wisdom
PE replaces QE
Event
The FOMC announced a new method of monetary easing.
Impact
In 2002, Ben Bernanke laid out policies that could be used to defeat deflation.
One of these was the use of interest rate “targets” along the yield curve.
Although explicit interest rate capping beyond the overnight rate was not
announced by the FOMC, the decision to keep the policy rate unchanged until
mid-2013 will have a similar effect.
One risk factor for investment in longer-term financial assets has been
removed. As Treasury yields fall to new lows in response to this policy there
will be a temptation to invest in riskier assets and lock in a spread. The shift to
price easing from quantitative easing may have a surprisingly large effect on
financial markets.
Analysis
Why did the FOMC decide to shift to a form of price easing rather than
engage in more quantitative easing? Perhaps there were not enough numbers
on the FOMC to get such a policy approved. But perhaps this is also an
important shift in FOMC thinking.
When he was a freshly-minted governor of the Federal Reserve Board, Ben
Bernanke gave a landmark speech which set out the policies that could be
deployed to prevent deflation. A lot of these policies now have ticks against
them.
One of the most interesting sections of the November 2002 speech was the
suggestion that the Fed peg interest rates beyond the overnight fed funds
rate.
“There are at least two ways of bringing down longer-term rates, which are
complementary and could be deployed separately or in combination. One
approach, similar to an action taken in the past couple of years by the Bank of
Japan, would be for the Fed to commit to holding the overnight rate at zero for
some specified period. Because long-term interest rates represent averages of
current and expected short-term rates, plus a term premium, a commitment to
keep short-term rates at zero for some time – if it were credible – would induce a
decline in longer-term rates.”
With this context it is not hard to understand the motivation of the FOMC in
promising to keep the fed funds rate near zero for almost two years. And
judging by the reaction in the Treasury market so far, it has been a
resounding success. Anyone who believed that the end of QEII or a ratings
downgrade would push Treasury yields higher has been turned into roadkill
under the wheels of the FOMC juggernaut.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Unconventional Wisdom
PE replaces QE
Event
The FOMC announced a new method of monetary easing.
Impact
In 2002, Ben Bernanke laid out policies that could be used to defeat deflation.
One of these was the use of interest rate “targets” along the yield curve.
Although explicit interest rate capping beyond the overnight rate was not
announced by the FOMC, the decision to keep the policy rate unchanged until
mid-2013 will have a similar effect.
One risk factor for investment in longer-term financial assets has been
removed. As Treasury yields fall to new lows in response to this policy there
will be a temptation to invest in riskier assets and lock in a spread. The shift to
price easing from quantitative easing may have a surprisingly large effect on
financial markets.
Analysis
Why did the FOMC decide to shift to a form of price easing rather than
engage in more quantitative easing? Perhaps there were not enough numbers
on the FOMC to get such a policy approved. But perhaps this is also an
important shift in FOMC thinking.
When he was a freshly-minted governor of the Federal Reserve Board, Ben
Bernanke gave a landmark speech which set out the policies that could be
deployed to prevent deflation. A lot of these policies now have ticks against
them.
One of the most interesting sections of the November 2002 speech was the
suggestion that the Fed peg interest rates beyond the overnight fed funds
rate.
“There are at least two ways of bringing down longer-term rates, which are
complementary and could be deployed separately or in combination. One
approach, similar to an action taken in the past couple of years by the Bank of
Japan, would be for the Fed to commit to holding the overnight rate at zero for
some specified period. Because long-term interest rates represent averages of
current and expected short-term rates, plus a term premium, a commitment to
keep short-term rates at zero for some time – if it were credible – would induce a
decline in longer-term rates.”
With this context it is not hard to understand the motivation of the FOMC in
promising to keep the fed funds rate near zero for almost two years. And
judging by the reaction in the Treasury market so far, it has been a
resounding success. Anyone who believed that the end of QEII or a ratings
downgrade would push Treasury yields higher has been turned into roadkill
under the wheels of the FOMC juggernaut.
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