No QE3 … Yippee!
March 13, 2012
by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Key Points
- The Fed made no major changes to its policy statement and announced a continuation of Operation Twist, but did not hint at or announce further quantitative easing.
- The Fed's assessment of the economy did improve somewhat.
- Richmond Fed President Lacker's dissent and Dallas Fed President Fisher's pronouncements ring true.
In the policy statement released at the conclusion of its latest meeting, the Federal Reserve upgraded its assessment of the economy, noting improvement in labor conditions, and did not suggest imminent additional monetary easing, while keeping the fed funds rate in the 0-0.25% range it's been in since the end of 2008. Key in the statement released by the Federal Open Market Committee (FOMC): "Labor market conditions have improved further; the unemployment rate has declined notably in recent months but remains elevated."
Lacker dissents … again
There was one dissenter, Richmond Fed Bank President Jeffrey Lacker, who did so for the second consecutive time and who "does not anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014."
As for financial conditions, "strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook." The Fed made no change to what's become the key sentence in its statements, noting that conditions would probably warrant "exceptionally low" short-term interest rates at least through 2014.
The Fed also subtly upgraded its assessment of the investment environment. Business investment spending is said to have "continued to advance," whereas in its January 25 statement the FOMC said it "has slowed."
Addressing energy prices
There wasn't much new in the Fed's statement other than addressing the short-term inflationary implications of the recent spike in energy prices. Inflation "has been subdued in recent months although prices of crude oil and gasoline have increased lately." The increase in oil prices "will push up inflation temporarily, but the committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate."
Operation Twist continues, but no QE3
"The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September." In other words, "Operation Twist" is ongoing, but there was no mention of extending it beyond its scheduled June expiration. That will likely be discussed and detailed at the next FOMC meeting in late April.
For those who'd been expecting a third round of quantitative easing (QE3)—and we were not among them—the reasoning is likely already noted above: the economy has not only picked up its pace of growth, but the unemployment rate has also begun to ease meaningfully. Remember, both price stability (inflation) and resource utilization (maximum employment) are the Fed's mandates. With recent conflicting data on both, and the rarity of the Fed changing course amid conflicting signals, QE3 was unlikely in our opinion.
Personally, I disagree with the many who feel the only prop under this very strong market has been quantitative easing. I do believe the economy has entered the second phase of the recovery (the expansion phase) in which jobs will be more plentiful, small businesses will be greater participants, and even housing will be a positive contributor. The market's recent strength—and importantly, its surge immediately after the Fed's announcement into today's close—supports this view.
Fisher speaks the truth
The subject of QE3 was likely discussed and debated, but we'll have to wait until the minutes of the meeting are released in three weeks to get any details. I share the view of Richard Fisher, President of the Dallas Fed, who's publicly said that economic conditions are improving and the underlying trend of inflation is "converging on the Fed's 2% target." Key to Fisher's perspective is that the liquidity injected into the financial system via QE1 and QE2 hasn't traveled into the real economy, but instead sits on banks' balance sheets, invested in financial assets, parked in cash—or even parked at the Fed itself.
Why keep treating a recovering patient like it remains in the operating room? Fisher recently said, somewhat bluntly, that he sees "no need to administer additional doses unless the patient goes into postoperative decline." He went on to suggest that if incoming data continues to show accelerating improvement in the economy, "the markets should begin preparing themselves for the good Dr. Fed to wean them from their dependency rather than administer further dosage." Hear, hear.
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