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Wednesday, February 09, 2011

NY Fed's Brian Sack: Implementing the Federal Reserve’s Asset Purchase Program

by Calculated Risk on 2/09/2011 05:45:00 PM

From NY Fed Vice President Brian Sack: Implementing the Federal Reserve’s Asset Purchase Program. This is for those interested in how the asset purchase program (QE2) works. A couple of excerpts:

[T]he Desk has been able to purchase large volumes of securities in a rapid manner, as required by the policy decisions made by the FOMC. Indeed, over the period since the FOMC's decision to expand the SOMA portfolio, the Desk has purchased about $300 billion of Treasury securities. That total includes about $220 billion of purchases out of the intended $600 billion expansion of the portfolio, and another $80 billion of purchases associated with the reinvestment of principal payments on agency debt and mortgage-backed securities. In terms of the monthly pace, the purchases so far have been running at about $105 billion per month, consisting of roughly $75 billion in new investments and $30 billion of reinvestments. To meet this pace, the Desk has been operating in the market on nearly every available day.
And on the recent increase in rates:
Since early November, one of the notable developments in financial markets has been the sharp increase in longer-term interest rates. At first glance, this change may seem at odds with the portfolio balance channel. However, it is important to understand the factors that led to the increase in interest rates in the current circumstances.

The upward movement in longer-term interest rates in large part reflects the greater optimism among investors about the outlook for economic growth. Investors revised up their baseline forecasts for the economy and reduced the perceived downside risks that they see around that outlook. This shift in the outlook led the market to price in the possibility of earlier increases in short-term interest rates and to scale back the size of asset purchases that they expect from the Federal Reserve. Both of those developments contributed to the significant rise in yields.

In contrast, the rise in yields does not appear to be driven by the concerns expressed by some that the asset purchase program would unleash a considerable rise in U.S. inflation and inflation expectations to levels well above those consistent with the Federal Reserve's mandate. Such an outcome would be detrimental to the economic outlook, leading to downward pressure on risky asset prices and a substantial weakening in the value of the dollar. However, what has taken place in U.S. markets to date does not resemble this outcome. Indeed, over the period since the November FOMC meeting, longer-term inflation expectations have remained at levels consistent with the Federal Reserve's mandate, risky asset prices have advanced and the dollar has held its ground.