FT: October interim FOMC committee meeting

At the October 15 meeting, held by video conference, the Fed discussed whether it should target a long-term interest rate, suggesting this could be an option if inflation continued to fall in the face of the central bank’s new $600bn round of quantitative easing, nicknamed QE2. But the meeting rejected the policy change.
EDITOR’S CHOICE

Targeting a long-term interest rate – fixing the 10-year yield at 2.5 per cent, for example – would commit the Fed to buying an unlimited amount of Treasury securities if the public wanted to sell them at that price. At the moment, the Fed can choose to buy more or less than $600bn, but with a long-term rate target it might lose control of the size of its balance sheet...



FOMC members slashed their growth and inflation forecasts for the next few years and sharply increased their expectations of unemployment.

In a crucial argument supporting the case for QE2, most of the FOMC forecast that core inflation in 2013 will be between 1.1 and 2 per cent. That justifies action because he Fed’s objective is ‘about 2 per cent or a bit below’.

The committee also expects to miss its other goal on jobs with unemployment forecast to be between 7.7 and 8.2 per cent at the end of 2012 – up from a June forecast of 7.1 to 7.5 per cent – and 6.9 to 7.4 per cent at the end of 2013.

A few committee members also increased their estimate of the number of people who will remain out of work once the economy has fully recovered.

The ‘central tendency’ estimate – which excludes the three highest and three lowest forecasts by individual FOMC members – rose from between 5 and 5.3 per cent to between 5 and 6 per cent.

Most FOMC members now expect growth of between 3 and 3.6 per cent in 2011 compared with the 3.5 to 4.2 per cent that they forecast in June, but they remain optimistic that growth will accelerate to about 4 per cent in 2012.

BEA QIII report

FT: revised QIII growth up, QE2 profits

Consumer spending up, revised GDP growth in QIII 2.5%
Consumer spending, which accounts for about 70 per cent of economic activity in the US, grew 2.8 per cent compared with the previous estimate of 2.6 per cent. That is the fastest such increase in four years and contributed 2 percentage points to the growth rate.

The revised data suggest that the summer slowdown in the US economy was not as severe as previously thought but growth is still not fast enough to bring down the 9.6 per cent unemployment rate...

Corp profits up 12.5%:
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New data released by the BEA also showed that while workers continue to struggle, corporations have bounced back from the recession. Corporate profits surpassed their peak level of four years ago during the third quarter to reach an all-time high of $1,659bn.

Profits have recovered rapidly as US companies benefit from cost cutting during the downturn and booming earnings from emerging markets. But they remain slightly below their peak as a share of GDP, at 12.5 per cent compared with the 12.8 per cent that they reached in 2006.

FED makes 62.4B in QE2
Profits earned by the Federal Reserve reached an all-time high of $62.4bn at an annualised rate in the third quarter even before the central bank began to expand its balance sheet further.

The Fed is making enormous profits because it earns more on the long-term bonds it buys as part of its quantitative easing programme than it pays to banks on their reserves. The Fed paid $35bn in profits across to the Treasury in the first half of this year.

FT: LSE's derivatives business

FT: OECD forecasts slower growth

FT: Fed defends monetary easing

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A group of Republican economists have also written an open letter to Fed chairman Ben Bernanke saying that the “planned asset purchases risk currency debasement and inflation”. Separately, countries from Brazil to Germany have attacked the policy as a ploy to weaken the dollar.

Fears that the heavy opposition could prompt the Fed to stop its asset purchases short of $600bn led to heavy selling of Treasury bonds on Monday. The yield on 10-year US Treasury notes rose above 2.9 per cent, returning to the levels of early August, before the Fed’s latest round of easing was priced in.

FT: QE2 toll

FT: fun with the financial crisis

FT: Shakeout with QE2, rates rise

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One explanation for the suddenness of the sell-off in Treasuries is that the market was almost completely one-sided owning bonds, because the Fed had already telegraphed QE2 well in advance.

“The easy answer is to say buy the rumour, sell the fact and, in this case, that’s what has happened,” says Michael Kastner, principal at Halyard Asset Management.

In other words, with QE2 priced in, the market responded by establishing a better balance between buyers and sellers. Indeed, it was not just Treasuries that have experienced a post-QE2 shakeout. The rise in bond yields late last week was accompanied by a sharp drop in commodity prices and a retreat in equities.

FT: US financial regulations

FT: G20, currency issues

FT: QE2 in U.S.

...Supporters of QE have received a huge boost in recent weeks. Since Ben Bernanke, Fed chairman, delivered a pivotal speech to central bankers in Jackson Hole, Wyoming, on August 27 – which made markets believe QE2 would come – the degree to which yields on spread between yields on regular 10-year Treasury bonds exceed those of inflation-protected 10-year Treasury bonds (a proxy for inflation expectations) has risen from 1.6 to 2.1 percentage points. In addition, the trade-weighted dollar has fallen more than 4 per cent.

These moves show that markets believe QE2 is capable of moving asset prices, at least. Lower rates and a weaker dollar should stimulate the economy. Mr Bernanke and the Fed believe QE works by changing the balance of risks on offer to the private sector. By buying large numbers of risk-free long-term Treasury bonds, they think they can force the public either to pay more for similar bonds or to invest in something else...

Plan B would most likely be a change in communication – whereby, instead of trying to push down long-term interest rates, the Fed would try to push up expectations of future inflation.

It could do this either by promising to keep interest rates close to zero for a long time – regardless of what happens to inflation – or by adopting a “price-level target”. A price-level target is, in essence, a pledge to compensate for low inflation today with higher-than-target inflation in the future.

“Clearly communicating an ex­pected path for prices would help guide the public’s understanding of the Fed’s intentions while we carry a large balance sheet and promise continued low interest rates for an extended period,” said Charles Evans, the president of the Chicago Fed, in a recent speech.

Plan C would be a more extreme form of quantitative easing. Instead of targeting an amount of assets to buy, the Fed could target an interest rate – such as 2 per cent for the 10-year Treasury bond – by offering to buy as many bonds as needed to reach that rate. Mr Bernanke raised this option in a famous 2002 speech widely seen as the instruction manual for how a central bank should tackle deflation.

Buying an unlimited amount of bonds means losing control of the Fed’s balance sheet, however, so it is a deeply unpalatable option. But it is not as extreme or unpalatable as plan D: buying as many Treasury bonds as Congress needs to cut all taxes on payrolls to zero for a time.

Such a policy would be extremely risky. It would be conceivable only if the US was already mired in deflation. But its existence gives the lie to any claim that the Fed would be out of ammunition if QE2 did not work.

FT: bond bubbles, arguments

...But government bonds are, to him, much closer to “random walks” and he thinks he can predict their direction over only a few weeks.

“Government bonds are the most likely to switch direction with very little notice,” he says. “For corporate bond spreads, there is a little more time to become wise to likely moves.”

... Prospects for treasuries

QE2 ready to set sail towards historic lows

Investors expect that some $1,200bn in new US Treasury paper will be sold in the coming year, and that could be matched by purchases from the Federal Reserve and other central banks looking to keep their currencies lower against the dollar.

Consensus in the bond market about the size of this second round of “quantitative easing” to stimulate the economy is for the Fed to buy $100bn a month of Treasuries until core inflation starts rising and/or unemployment is falling. Whether this includes current Fed purchases of $30bn a month from reinvesting proceeds from its holdings of expiring mortgages remains to be seen, say traders.

The yield on 10-year Treasury notes sits at 2.65 per cent and is down from a high of 4 per cent in April. The benchmark yield is seen as falling towards 2 per cent once QE2 starts. That would eclipse its modern low of 2.04 per cent, set in December 2008 at the height of the financial crisis.

FT: Sovereign defaults unlikely

...Moody’s adds that worries that one of these countries may be forced to restructure or default has centred on their rising debt burdens. However, this is neither a necessary or sufficient condition for a sovereign default, the agency says.

The past 20 defaulters have also had high foreign currency exposure, an average of 76 per cent of total debt was in foreign currency before the default.

In the case of Greece, Portugal and Ireland, their debt is almost entirely in euros, their domestic currency, although a majority of their bonds are held by institutions in other eurozone countries.

FT: Strong Chinese and US data boost equities markets

FT: The Fed's QE2 this Wednesday. Nov 3

...Rather than a huge programme of asset purchases all announced up front, the Fed has made clear that it wants QE2 to evolve in size depending on the economic data. But it is still likely to make a downpayment by pledging at least some asset purchases on Wednesday: $500bn is a likely figure for this initial round of buying.

It will also set a buying speed. The Fed already has to buy $30bn of Treasuries a month in order to reinvest early repayments from its portfolio of mortgage-backed securities, so it is unlikely to want to buy more than a further $80bn-$100bn a month. If the initial figure were $500bn, it could therefore pledge to buy them over the next two quarters. Far more important, however, is what the Fed says about further purchases once the initial round is complete.