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Wednesday, March 18, 2009

The Market Loves Monetary Policy

The Federal Reserve just made an announcement that shook the entire financial world.

The Federal Reserve’s policy committee on Wednesday said that the Fed would buy more than $1 trillion in assets to revive credit markets, also leaving its target interest-rate range of 0% to 0.25% unchanged and signaling that the economy still has a long way to go before it recovers.

The Federal Open Market Committee said it would buy up to $300 billion in longer-term Treasuries over the next six months, up to an additional $750 billion in agency mortgage-backed securities (bringing the total this year to $1.25 trillion) and up to an additional $100 billion in agency debt (bringing the total up to $200 billion).

This is loose monetary policy on steroids. The announcement was immediately followed by the U.S. Treasuries dropping nearly half a percent in yield with mortgage rates in the same vicinity. Furthermore, the Dow which was slightly down prior to the announcement, is now up about 2% for the day (along with most other indices).

This latest announcement will likely mean that the Fed will follow through on their intention to drive mortgage rates to 4.5%. This will also filter an extr one trillion in cash into the system.
(through the purchase of these bonds)

This is the real life example of why those that favor monetary policy favor it. In one fell swoop, the Federal Reserve just created a trillion Dollars. (that's how much they will dump into the system by buying all of these bonds) Meanwhile, the stimulus signed into law a month ago has only spent a few billion. Whereas the Fed will take about six months to buy up all of these bonds, the stimulus will still be spending six years from now.

The market is also a lot more confident in the policies of Bernanke than of Obama. Most policy announcements of the Obama are followed by a decline in the market. Fed announcements are usually followed by increases.

The short term euphoria must also be tempered with some sobering news. First, the Fed has announced through action that our economy is in really bad shape. Flooding the market with a trillion in new Dollars is not done in any economy that is doing well. Which makes me wonder why Bernanke told 60 Minutes that he thought the recession would end by the end of the year. Second, this is NOT merely loose monetary policy but wide open. The sort of inflation potential in this move combined with everything else they have done is obscene. We are, in my opinion, creating a very bad speculative market down the road.


Roy Lofquist said...

Let's see - there's a credit crunch so the Fed lowers the interest rate to zero to encourage people to lend money? I'm switching to gin. Whiskey has obviously confused me.

Anonymous said...

I can't say I'm surprised by this move. The US has joined the UK, CHF, and JPY in what they call "quantitative easing" by printing new money.

So far the European Central Bank is the only one that has not committed to quantitative easing. That's probably why the Euro skyrocketed from $1.30 to $1.34 in the 15 minutes following the announcement.