Bernanke Launches QE3 to Battle Unemployment

on Sep 17, 2012

On Thursday 13 September, Ben Bernanke of the US Federal Reserve proved to be the Fed’s most innovative chairman as he launched the much-anticipated third round of quantitative easing. Via QE3, $40 billion (£25 billion) of extra funds will be injected into the economy each month through purchases of mortgage-backed securities (MBS). In a press conference following the two-day Federal Open Market Committee (FOMC) meeting, Bernanke pledged the central bank will continue buying assets until an “ongoing sustained improvement in the labour market” is seen.

The unemployment rate, which has been stuck at above 8 percent since February 2009, was described by Bernanke as a “tremendous waste of human skills and talents”. The new round of quantitative easing is supposed to battle it down although the Fed chairman did not provide more details as to what levels are pursued. “There is not a specific number we have in mind but what we’ve seen in the last six months isn’t it” he said in the press conference. It is likely for the new programme to last for quite some time, while being backed by Bernanke, whose term as chairman ends early 2014.

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Combined with the second run of “Operation Twist” which is gradually adding to the economy around $267 billion (£165 billion) from July 2012 to December 2012, the Fed will be buying assets at a pace of $85 billion (£52 billion) a month for the rest of the year. About $3.5 billion (£2.1 billion) of mortgage-backed securities will be bought up by the Fed every day. According to figures by Barclays Capital, the average monthly issues of agency securities are about $130 billion (£80 billion).

After the news of QE3 came out, there was an immediate influx of investors into the agency-backed securities market, which pushed the yield on Fannie Mae mortgage securities down by 24 basis points to 2.12 percent. It was a quick transition from the previous Treasuries sell-off frenzy, which was provoked by investors’ belief that the central bank’s easing programme will be targeting Treasuries. According to Bloomberg, the investors rush after the announcement narrowed the Mortgage backed-securities (MBS) spread over Treasuries to their lowest level since 1992.

!m[](/uploads/story/377/thumbs/pic1_inline.png)“This is big and it is powerful,” said Scott Wede, head of US securitised products trading at Barclays. “With this announcement, the Fed is really putting a cap on mortgage yields for the foreseeable future, while spreads are also likely to tighten and volatility may fall.”
According to HSH, a mortgage research firm, the recent drop in MBS yields would feed into rates on new mortgages almost instantly with those rates potentially dropping by a quarter-point from the current 3.65 percent average. The Fed’s reasoning is that low mortgage rates will give a boost to refinancing, wake the housing market of its slumber, speed up the US economic recovery and lead to the end-game of bringing down unemployment.

Bernanke assured inflation is not a concern for now and reminded that the Fed has delivered on its mandate of price stability since the mid-1990s. According to analysts, this record gives the chairman enough credibility to unleash quantitative easing without provoking inflation expectations. “As he himself said, the Fed has built up a lot of capital with respect to inflation credibility,” said Neal Soss, chief economist for Credit Suisse Group AG in New York “The point of having capital is, from time to time, to spend it.” Despite that, the break-even rate for five-year Treasury Inflation Protected Securities rose to 2.21 percentage points from 1.92 points on August 30, the day before Bernanke spoke in Jackson Hole, Wyoming and hinted he might have to introduce new stimulus for the economy. The rate represents an yield difference between the inflation – linked debt and comparable maturity Treasuries and is a measure of the outlook for consumer prices over the life of the securities.
The announcement was followed by an immediate backlash from the Republican Party including presidential candidate Mitt Romney. Romney’s campaign director Lanhee Chen on QE3:
“After four years of stagnant growth, falling incomes, rising costs and persistently high unemployment, the American economy doesn’t need more artificial and ineffective measures. We should be creating wealth, not printing dollars.”
Bernanke accentuated that the central bank didn’t take into account the November presidential elections. “We have tried very hard to be non-partisan and apolitical. We make our decisions entirely on the state of the economy.” he reiterated. The Fed Chairman was appointed by George W. Bush but president Obama kept him for a second term. Romney has already stated that if he gets elected he would not keep Bernanke as head of the central bank.
The announcement of QE3 comes a week after Mario Draghi, president of the European Central Bank (ECB), announced his bond-buying plan to support Eurozone countries in distress. Investors around the world seem to have been given some solid evidence that policymakers are willing to take the hard decisions and implement bold monetary policies to battle weaknesses in their economies. Markets have reacted positively but it is yet unclear on whether the thumbs ups will turn out to be short-swing optimism or evolve into the long-term benefits desired by policymakers.


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