Markets had been expecting Federal Reserve chairman Ben Bernanke to refill the punch bowl. He did, but he forgot the fruit juice. The Fed is now ladling out straight booze.
Quantitative easing 3 is here. The Fed will buy $40bn of agency mortgage-backed securities a month, and keep rates at rock bottom levels through mid-2015, versus the old target of late 2014. And QE3 has two intoxicating ingredients that distinguish it from earlier rounds. First, the Fed did not set a limit on the amount of securities purchases it would make. It plans to keep buying until the labour market improves “substantially” (though what Bernanke means by this is unclear; he’ll know it when he sees it, apparently). Second, the Fed plans to keep policy accommodative “for considerable time” after the economy strengthens, signalling that it would not be deterred even if inflation picks up periodically. If that wasn’t enough, the option of additional measures was left open, should the job market stay weak.
This 80-proof accommodation should allow this year’s party in risk assets to continue – in the short term. The S&P 500 was already up 14 per cent this year, and added nearly 2 per cent after the announcement. The materials sector was up 2.5 per cent. Homebuilder stocks, many of which have doubled this year, were positively giddy, as mortgages should stay cheap. Junk bonds yields, already at all-time low yields near 6 per cent, could well head lower.
It has always been clear that Fed activism supported risk assets by enticing savers out of low-risk ones, as well as putting money in homeowners’ pockets by driving mortgage rates down. What nobody knows is the degree to which people made nominally richer in this way will turn around and pump money into the rest of the economy. The Fed is determined to find out. Bottoms up!