Federal Reserve's QE Has No Clear End, But There's Little to Fear From Its Continuation

On Wednesday, the Federal Reserve announced that it would continue the combination of low interest rates and quantitative easing (QE) that it has been since the onset of the economic slowdown. This did not come as a surprise to most, and all but one of the thirteen members of Federal Open Markets Committee voted in favor of continuing the current policy, which means that interest rates will continue to remain near zero percent, and the Federal Reserve will continue purchasing additional agency mortgage-backed securities (MBS) at a rate of $40 billion per month, and Treasury bonds at a pace of $45 billion per month.

The markets, as I mentioned in my piece onthe rise in the Dow Jones, have been rising as a result of the influx of cash courtesy of QE. The $85 billion that cannot go into Treasuries or MBSes must go elsewhere, and thus they have gone into the markets. Many have worried about QE’s effect upon inflation, but the reality is that there has been little — inflation has refused to budge. Such fears, then, of skyrocketing food prices, of such things adversely affecting the average person, seem to have less to do with economic concerns than ideological talking points.

A more interesting question then, is what next? The market is not being sped out of control by the Fed’s policy, but rather just being sustained by it. If it ends, might the bottom fall out altogether? Part of the reason analysts have such a difficult time predicting the course of the post hyper-expansionary policy economy is because they don’t know how precisely the Fed will go about ending it. Indeed, nor does the Fed.

It is not feasible for the Fed to go about and simply stop purchasing Treasuries and MBSes — that would induce a terrible shock into the markets, and the economy as a whole, so such purchases would have to be gradually reduced. But there is the threat of bad assets on the Fed’s books. If the U.S. government were to default, even in the case of a technical default (which would almost certainly result in more credit ratings agencies downgrading the U.S.), the value of Treasuries would drop, and the Fed would be forced to purchase at a loss.

If the market were to be jittered, default or no default, it could cause another downturn in the housing market, causing another wave of foreclosures and MBS failures — which is what fuelled the recession in the first place. The purchase of Treasury bonds is a typical part of the Federal Reserve’s monetary policy arsenal. What is unconventional about QE is the purchase of MBSes, and a failure of those would leave the Federal Reserve with bad, unloadable assets.

But while both events are fairly unlikely, uncertainty abounds about the end of QE and rock-bottom interest rates. It remains to be seen how the Federal Reserve will make that conclusion, and furthering that issue is the fact that several other central banks are facing the same dilemma. But the bottom line is that neither markets nor consumers should have anything to fear from its continuation.