What is QE3: Bernanke Sends Stocks Soaring With Fed Actions

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On Thursday, the Federal Open Market Committee announced that the Federal Reserve will purchase $40 billion a month in mortgage-backed securities indefinitely (MBS) from financial institutions, will keep interest rates at zero percent until at least 2015, will make additional purchases if the employment picture doesn't improve, and in general will maintain an stimulative policy for a "considerable time."

This is the third time since the financial crisis began that the Fed has enacted a program of quantitative easing, or QE (hence QE3). The Fed implements QE by purchasing securities, typically bonds, or in this case, mortgage-backed securities from financial institutions. The goal is to infuse these institutions with cash to spur lending, and also to drive down yields on bonds. Coupled with its accommodative zero interest rate policy, the Fed hopes to discourage safe-haven investing and create demand.  

The announcement sent stock and commodities prices soaring, and the U.S. dollar plummetting, as the Fed gave a clear indication that ZIRP and monetary stimulus will be the new normal going forward. Although the announcement would seem to fall short of the expectations many had -- that the Fed would make asset purchases totaling upwards of $400 billion over the coming months -- the open-ended nature of the Fed's latest action makes it clear that more monetary stimulus is not only possible, but probable.

Markets reacted sharply, as one would expect. The announcement caused a spike in the DJIA.

Meanwhile, the EUR/USD endured a 60 pip swing almost instantaneously:

There are also potential political ramifications of the Fed's latest announcement. The newest round of asset purchases will provide Mitt Romney's campaign with some ammunition, as he will likely point to the enactment of QE3 as a stark admission that the economy is in dire straits, and that President Obama is in over his head. Romney has said he opposes QE3.

FULL FOMC STATEMENT:

Release Date: September 13, 2012

For immediate release

Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months.  Growth in employment has been slow, and the unemployment rate remains elevated.  Household spending has continued to advance, but growth in business fixed investment appears to have slowed.  The housing sector has shown some further signs of improvement, albeit from a depressed level.  Inflation has been subdued, although the prices of some key commodities have increased recently. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.  The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.  Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.  The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. 

The Committee will closely monitor incoming information on economic and financial developments in coming months.  If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.  In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.  In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.  Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for the federal funds rate are likely to be warranted.

Statement Regarding Transactions in Agency Mortgage-Backed Securities and Treasury Securities

END