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QEQuantitative easing has died for the third time, but easy money lives.

On October 29, 2014, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to conclude the current asset purchase program.

The 12 members of the central bank’s committee also voted to keep its key interest rate near zero. This means people with savings in the bank get little to no interest.

The Fed’s diagnosis: Deflation, not inflation, was putting the economy in grave danger.

“We’re writing the eulogy on the most extreme Federal Reserve intervention in history,” says Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

The Federal Reserve’s job of keeping the economy humming was extraordinarily difficult during the 2007-09 financial crisis. The housing market collapsed; banks and investors stopped lending; the stock market endured its worst fall since the Great Depression; unemployment soared.

The central bank pushed the key short-term funds, which would let businesses and consumers borrow at cheaper rates.

But that still wasn’t enough to get the economy out of the intensive-care unit. So the Fed began buying long-term securities — Treasury bonds and mortgage-backed securities — to push long-term rates lower. The Fed essentially created the money to buy the bonds, expanding the U.S. “money supply.”

The bank started its bond program, known as quantitative easing or “QE,” in November 2008 to supposedly “aid the economy and the crippled housing market,” but the fact is it created an even worse downward spiral. It became the flagship program of former Fed Chairman Ben Bernanke’s term in office.

economic crisis$223.3 trillion: The total indebtedness of the world, including all parts of the public and private sectors, amounting to 313% of global gross domestic product.

*Money Printing
*Wall Street is already thinking about QE4
*Huge amount of bonds it holds on its more than $4.4 trillion balance sheet.
*Number of the Week: Total World Debt Load at 313% of GDP
*Debt is an increase in current spending in lieu of a decline in future spending

What will the post-QE era look like?

• Low short-term rates. A neutral position for the fed funds rate is about 4%, says Kevin Cummins, economist at Harris private bank. “We’re not going to see that for quite a while,” he says. The bank thinks the Fed funds rate will hit 1.25% to 1.5% by the end of 2015, and may not hit 4% until after 2016. Others think that neutral may well be lower than it has been historically because of low U.S. population growth and slow gains in productivity.

• Low long-term rates. Deflation in Europe and Japan, as well as sluggish loan demand in the U.S., could keep long-term rates low for a long time. If the average 30-year fixed mortgage rate rose to 5% from 3.92% now, fewer houses would be built, the unemployment rate would go up, and the economy would slow down, LeBas says. And the Fed has taken more than $4 trillion out of the bond market. “This will place downward pressure on market interest rates, even without any new buying,” says Tony Crescenzi, portfolio manager for Pimco.

• Higher dollar. Even though the Fed’s easy money policies are still in place, Europe and Japan remain mired in deflation with even lower interest rates than the U.S. Money flows toward higher interest rates, and money will be flowing toward Treasuries and other U.S. securities, trying to push the dollar higher.

For investors, don’t hold your breath for a blast of money to come from the bond market to the stock market. “About 40% of the bond market is owned by investors who can’t sell,” LeBas says. Banks and insurance companies, for example, have to buy bonds to fund parts of their business.

As the Feds stop QE, Wall Street is already speculating the central bank could crank up a new bond-buying program to take its place as the economy continues to sour. They also saw a 15.1 percent chance of a recession in the next year.

“I think at this point, people and economists, have become conditioned, and not incorrectly, that when things turn south that QE is just a part of the toolkit, rather than some sort of unusual policy,” said Daniel Greenhaus, chief global strategist at BTIG. “With interest rates this low, that’s probably not an unfair assumption.”

There are many arguments for and against the Fed’s historic policy decision to buy bonds.

“We’re going to be debating the efficacy of the quantitative easing programs for the next 100 years,” says Greenhaus. “Its legacy is undetermined because the war isn’t over.”

Fed watchers say the Fed is unlikely to change the language in its statement about keeping rates low for a “considerable time.” That was the focus of speculation last month, as was the idea that it could alter the language about labor market conditions.

“They don’t want to send the wrong signal. They don’t want to spook the markets. I think they’ll be a little more bullish on the labor markets but they’ll pivot to inflation. They’ll be more worried about inflation,” said Diane Swonk, chief economist at Mesirow Financial. “The markets seem pretty well prepared. The Fed has prepared them for tapering.”

Besides keeping short-term rates low, Fed watchers say it hopes to suppress longer-term rates with the huge amount of bonds it holds on its more than $4.4 trillion balance sheet. The 10-year yield was at 2.33 percent Wednesday, rising ahead of the Fed statement.

Swonk also expects the Fed to remain open to another round of quantitative easing even though it wants the program to end. “They have to leave the door open to QE4, but they really don’t want to do it. Is it the flow or the stock? They made clear they want to keep the balance sheet steady until they start raising rates,” Swonk said. The stocks are the securities on the balance sheet, and the “flow” is the purchase of new securities.

“We’ve all become accustomed to QE in the sense that we lived with it for six years, but before the crisis the purchase of Treasury securities or assets at the medium to long end of the curve was always what you were supposed to do when interest rates fell to the zero bound,” Greenhaus said. The idea has now become main stream after the Fed embarked on three programs and Operation Twist, a version where it bought and sold securities.

Operation Twisted Logic

operation twistDEFINITION of ‘Operation Twist’

The name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds. “Operation Twist” describes a monetary process where the Fed buys and sells short-term and long-term bonds depending on their objective. For example, in September 2011, the Fed performed Operation Twist in an “attempt to lower long-term interest rates.” In this operation, the Fed sold short-term Treasury bonds and bought long-term Treasury bonds, which pressured the long-term bond yields downward.

The name “Operation Twist” was given by the mainstream media due to the visual effect the monetary policy action was expected to have on the shape of the yield curve. If you visualize a linear upward sloping yield curve, this monetary action effectively “twists” the ends of the yield curve, hence the name Operation Twist.

Defenders of this policy will argue that things would look even worse without it, and that for a while “quantitative easing” boosted equity markets and other risk assets. Hooray for that. Although it has to be said that the idea that we, the public, can easily be cajoled into feeling confident and behaving in more expansionary modes economically via the open manipulation of market prices strikes me as somewhat condescending and hubristic. But we are talking about a state agency here, so we shouldn’t be surprised.

“Operation Twist” is another attempt to keep interest rates low and to encourage borrowing when the present crisis is in fact the result of low interest rates and excessive borrowing. The only solution to our problems is to stop printing ever-larger quantities of money and to finally allow the market to set interest rates and to cleanse the economy of its accumulated dislocations.


Additional information on reinvestment’s in agency MBS and Treasury rollovers can be found in a set of Frequently Asked Questions in the following location:

FAQs: Agency MBS Reinvestments and Treasury Rollovers »

As announced on January 13, 2014, Treasury Floating Rate Notes will be treated in a similar manner to other Treasury securities in its reinvestment of proceeds received from maturing Treasury security holdings (see http://www.newyorkfed.org/markets/opolicy/operating_policy_140113a.html).

For a full list of SOMA holdings, please see http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html.

Federal Reserve

Federal Open Market Committee (FOMC)

Open Market Operations – Federal Reserve Bank of New York

History of Federal Open Market Committee actions

Meeting calendars, statements, and minutes (2009-2015)

Estimated Impact of the Federal Reserve’s Mortgage-Backed

Operation Twist Definition

Market pushes back Fed rate hike expectations: Survey

Fed will go out of its way to be dovish

FRB: Press Release–Federal Reserve issues FOMC statement–October 29, 2014

Total World Debt Load at 313% of GDP – WSJ Blogs – Wall …

$233.3 Trillion: Total World Debt Load at 313% of GDP

Roubini Analyst

Federal Reserve launches Operation Twist – Sep. 21, 2011

First Take: Beginning of the end of easy money

Operation Twisted Logic – Detlev Schlichter – Mises Daily