From PIMCO’s Tony Crescenzi on the QE issue, Fed and Bernanke’s choices.
- If the Fed does nothing, asset prices could fall, threatening America’s fragile economic recovery. But if the Fed decides to battle the forces of deleveraging, it could commit a classic error by acting during a turning point and thereby doing too much.
- During Operation Twist, the Fed will absorb the equivalent of all of the issuance of U.S. Treasury securities maturing beyond seven years. When Operation Twist ends, global investors will be left to shoulder the burden.
- The combination of stronger economic data and rebounding inflation expectations makes it more likely that the Fed will hint at rather than decide on QE3 when it meets again on April 25th.
Like Hamlet, Federal Reserve Chairman Ben Bernanke faces a choice; whether to “QE or not to QE,” which is to say whether or not to conduct a third round of Treasury, agency and/or mortgage-backed securities purchases in order to fend off the ravages of the deleveraging process. In other words, whether the Fed should conduct QE3 – a third round of quantitative easing.
Bernanke, thankfully, needn’t worry that the cost of his decision will be as fateful as Hamlet’s. Nevertheless, the decision on whether to conduct QE3 and thus provide additional fuel to reflate financial assets will be consequential, because the decisions rendered by the Federal Reserve affect millions of people, not only in the United States but throughout the world.
Doing nothing could disrobe the recent rally in risk assets and reveal it for what many believe it is, which is an unsustainable rally that will last only if ever more monetary stimulus is injected into the veins of global investors by the Federal Reserve and the rest of the world’s central banks. By this view, absent more “monetary morphine,” investors will focus more intensely on the troublesome debt burdens of the developed world. Therefore, if the Fed does nothing, asset prices could fall and thereby threaten America’s fragile economic recovery, which is built in part on rising asset prices and its attendant wealth effects.
If, on the other hand, the Fed decides to again take up arms to battle the forces of deleveraging, it could fall onto its dagger, committing a classic error in central banking by acting during a turning point and thereby doing too much, with the costs outweighing the benefits. In particular, if the Fed provides further monetary stimulus it could result in too much “bad inflation” and too little “good inflation” by boosting inflation expectations more than desirable without resulting in any meaningful gain in asset prices.