Focus On QE3
Q: What is QE3?
A: On September 13, the Federal Reserve announced a new round of asset purchases targeted exclusively at mortgage-backed securities, at a pace of $40 billion per month. With this move, the Fed has committed to expanding its balance sheet until the U.S. labor market substantially strengthens and vowed to maintain near-zero interest rates through mid-2015.
Even after the recovery strengthens, Fed stimulus would continue for a considerable time to ensure the economy is on solid footing. Federal Reserve Bank of Chicago President Charles Evans expects the third round of easing will help the economy keep growing despite headwinds from Europe’s debt crisis and the potential for tax increases and spending cuts in January triggered by the “fiscal cliff.”
With the addition of QE3, the Fed’s money creation will push past the $3 trillion level since quantitative easing began in 2008. The Fed will be buying $85 billion net worth of assets monthly through the end of the year. At that time they will revisit an extension of Operation Twist, which is set to expire at year-end, or other easing measures if needed.
Q: What is the Fed’s goal for QE3?
A: The Fed enacted QE3 to help bolster economic growth, improve liquidity in the markets, and ultimately create material, sustained improvement in the U.S. unemployment rate. The Fed’s underlying fear is that without further policy accommodation, U.S. economic growth might not be strong enough to generate sustained improvement to put people back to work.
Q: What is the near-term impact and long-term expectations for the markets?
A: Initial market reaction has been very positive, however, investor anxiety and performance chasing may have played a role in that. Due to the somewhat surprising nature of the Fed’s announcement, underinvestment may spark further gains.
Since the announcement, riskier, higher-yielding assets have benefited. In addition, the U.S. dollar has weakened further, creating favorable conditions for investing in non-U.S. dollar-denominated securities.
The long-term impacts of QE3 remain to be seen, however, we would point out that the Fed’s removal of $40 billion in mortgage debt supply from the market each month may potentially create demand for other fixed income assets as investors continue to reach for yield. This could cause spreads to tighten in those sectors, which would benefit investors.