Wednesday, November 3, 2010

The Fed Wants You to Buy Stocks and Bonds

I don't know if there is a precedent for this, but Fed Chairman Bernanke has an editorial in this morning's Washington Post explaining (defending?) the Fed's thinking to embark on another round of quantitative easing.

I'm still a little skeptical about QE2, but I think you have to give Bernanke the benefit of the doubt. His entire professional career (prior to coming to the Fed) was spent studying The Great Depression of the 1930's. Moreover, he was quite vocal during Japan's "lost decade" of the 1990's about what policy moves Japan's central bank should be doing.

In other words, he's thought about all of this at some length.

Here's a excerpt from the editorial. Note I have highlighted the part that might have some relevance for investors:

This approach {QE} eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

In other words, the Fed wants bond and stock prices to move higher, and is willing to throw a cool $900 billion ($600 billion + reinvestment of interest from existing holdings) into the capital markets between now and the end of June 2011 to help this happen.

Do you really want to bet against the Fed?

Then there was this comment in the FT yesterday after the QE2 announcement, written by Gavyn Davies. Here's an excerpt (again, I have added my highlights):

Clearly, the fuss is mostly about asset prices. The announcement of QE2 has broken new ground not so much in its initial quantum, but in the fact that the Fed is willing to embark on this unconventional programme in the absence of any obvious financial or economic emergency. In fact, it has been willing to do so in the face of recent economic data which are definitely not indicative of a double dip in the economy. The ISM figures released in the past few days suggest that the economy may re-accelerate in the current quarter, despite the Fed’s insistence that the recovery remains disappointingly slow.

And, importantly, the Fed said that it would be willing to adjust the pace and overall size of its asset purchases in the light of future economic circumstances, which may encourage the markets to believe that there is a “Bernanke put” underlying the equity market. Almost certainly, the Fed is happy to see rises in equity prices and declines in the dollar, despite warnings that this stance may induce bubbles to develop in the US and overseas.

QE2 is about asset prices, not the economy | Gavyn Davies blogs on macroeconomics |

I'm not sure about the longer run impact of QE2, but for now I think you need to be fully invested in the markets.