Wednesday, March 18, 2009

Blowing another bubble?

The minutes of the Federal Open Market Committee meeting were just released. The effect was quick and meaningful.

The Federal Reserve Bank has run out of room in monetary policy. It's hard to lower interest rates below zero. But wait! We have a rabbit in our hat! Quantitative Easing to the rescue!

The Federal Reserve has presented a plan to purchase billions and billions of mortgage backed securities, long term treasury bonds. Below is the language of the minutes.

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.

The Fed has promised to add dramatically to money supply by purchasing these bonds. This should help create the inflation impetus the economy needs to increase the flow of money. It is in line with Bernanke's monniker of Helicopter Ben after he stated some years ago that he would, "drop money from helicopters," to avoid deflation.

What was the immediate market response? Stocks up, Bonds up, gold up, dollar down.
Will that initial reaction hold? That is impossible to say in a dramatic economic environment with daily cross currents.

It is said that when the Fed taps on the brakes, somebody is going through the windshield. Conversely when it slams the accelerator to the floor we might want to buckle up.

John Barnyak