QE To Infinity: Not?

Bloomberg.com surprised me this AM with its lead story, as follows:

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month.

Central bankers, who next meet March 15, are about half way through their second round of bond purchases. To bring the program to a full stop in June, they must be confident that the economy is strong enough to endure higher long-term interest rates and rising expectations of an exit from the most expansive monetary policy in Fed history, said Dan Greenhaus at Miller Tabak & Co. LLC in New York.

“If this is a self-sustaining recovery that can withstand higher interest rates, then why not get the hell out?” said Greenhaus, Miller Tabak’s chief economic strategist. “Still, I am nervous about their ability to withdraw from this policy without broader disruptions.”

The Fed announced in November that it would buy $600 billion of Treasuries through June in a bid to boost the recovery and reduce an unemployment rate lingering near a 26- year high. The program, known as QE2 for the second round of so- called quantitative easing, followed $1.7 trillion of asset purchases that ended in March 2010.

Stock Versus Flow

Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman.

“We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.”

Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”

The bolded paragraphs (my doing) above are key. We can hope that this signals that the parties in Washington have agreed, at least in principle, on significant deficit reduction, so that ordinary debt market mechanisms can finance the Federal deficit without the central bank adding to the money supply as it has been doing with quantitative easing. Presumably, it is a show of confidence in the economy. Of course, a year ago a similar show of confidence gave way to the summer slowdown and QE2. Will past be prologue?

I don't know the answer to that, but we can hope this is a return to prudence, and that in turn there could be reason to abruptly rethink the entire weak dollar investment theme. After all, the markets sometimes are a lot smarter than any individual. "Rethink" does not necessarily mean "alter" or "abandon", however. In the prior economic cycle, the Fed did not overtly monetize the deficits, which of course were much smaller, but the private sector went wild with credit creation. Soaring commodities prices and a weak dollar were the speculative result; then the Fed began withdrawing liquidity, and the whole shebang came tumbling down. For now, leaving the important Mideast disturbance and all the known other issues aside, the cards look increasingly aligned for a traditional "sweet spot" year for economic activity. Low interest rates, lots of labor slack, a good deal of unused manufacturing capacity, and tons of fiscal stimulus. Plus lots of skepticism.

Interesting times.

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