Friday, June 12, 2009

Fed Putting Brakes on Quantitative Easing?


According to the Wall Street Journal:

Federal Reserve officials are unlikely to significantly boost purchases of U.S. Treasurys and mortgage-backed securities when they meet in late June ...

Interest rates on everything from business loans to home mortgages tend to move in tandem with Treasury rates [which have spiked in recent weeks]. If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.

Fed officials aren’t convinced that is happening yet, so they aren’t inclined to use their muscle to restrain bond yields any more than they have already set out to do. That could change if their views of markets and the economy change. Fed officials say much needs to be hashed out at the next meeting.
As Rolfe Winkler notes:

Over the last two weeks, while purchases of Treasurys have continued ($16 billion this week, $9 billion last week), purchases of agency debt have been small ($4 billion total) and in MBS the Fed has been a seller (-$3.5 billion).

One reason asset purchases may have slowed is that the Fed doesn’t want to waste the $1.75 trillion worth of ammunition it has. Besides $200 billion of Fan/Fred debt, they’ve committed to buying $1.25 trillion of MBS by the end of this year and $300 billion of Treasurys by August. They’ve already bought $157 billion of Treasurys, according to WSJ, and $556 billion of mortgage securities. There’s no reason the Fed needs to limit itself to $1.75 trillion, of course. It can print as much cash as it wants. But if central bankers spend too much too soon, they may have to increase their purchase commitments later.

Remember when Hank Paulson said his “bazooka” would save Fan and Fred? Bondholders called his bluff and forced the government to take the two into conservatorship.

My point is that the bond market is bigger than the Fed. If the Fed makes an open commitment to print money, inflation expectations may get out of hand quickly. That’s unlikely to be sure. Given the massive pile of debt under which we’re suffocating, deflation remains the biggest risk. (As debtors default, “wealth” is destroyed hence “debt deflation.”)


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