Monday, September 27, 2010

WSJ: Fed Weighs new QE Approach

by Bill McBride on 9/27/2010 06:20:00 PM

From Jon Hilsenrath at the WSJ: Fed Weighs New Tactics to Bolster Recovery

Rather than announcing massive bond purchases with a finite end, as they did in 2009 to shock the U.S. financial system back to life, Fed officials are weighing a more open-ended, smaller-scale program that they could adjust as the recovery unfolds.
Although QE2 isn't a done deal, I think it is very likely.

This article suggests two approaches: 1) a large scale purchase program ( longer-term Treasury securities), or 2) a smaller-scale program with the amounts set at each FOMC meeting.

In Fed Chairman Ben Bernanke's speech at Jackson Hole on Aug 27th, he seemed to favor the first approach:
The channels through which the Fed's purchases affect longer-term interest rates and financial conditions more generally have been subject to debate. I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which holds that once short-term interest rates have reached zero, the Federal Reserve's purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public. ...

The logic of the portfolio balance channel implies that the degree of accommodation delivered by the Federal Reserve's securities purchase program is determined primarily by the quantity and mix of securities the central bank holds or is anticipated to hold at a point in time (the "stock view"), rather than by the current pace of new purchases (the "flow view").
It is possible that they could do the smaller-scale program as a compromise (note: Hilsenrath clearly has great sources at the Fed). As I noted yesterday in Bernanke and QE2, there will be plenty of economic data between now and the two day meeting on November 2nd and 3rd, but the two key releases are the September employment report (to be released on October 8th) and the Q3 GDP advance estimate (to be released on October 29th). Barring a significant upside surprise in one or both of those reports, it appears likely that QE2 will arrive in November.

Now the question is how will they do QE2.