US Quantitative Easing Statement

Wednesday evening saw the long-awaited release of the FOMC plans for a second round of US quantitative easing, or QE2.

After keeping the markets in suspense for some time, the Federal Reserve has come to a decision. In an attempt to wind growth back up to pre-crash levels, $600 billion will be pumped into the US economy over several months. The plan is to purchase $75 billion of longer-term Treasury securities each month until June next year, in addition to the first tranche's $250–$300 billion of maturing debt, which the Fed is keen to reinvest. Interest rates were also pegged at their current record low of 0.25%, and will remain unchanged at this level for an ‘extended period’.

If this initial phase turns out to be successful, the Fed has accommodated the possibility of instigating further measures. David Choe, from our market research team, notes that the central bank ‘…will review the pace and overall size of the programme on a regular basis to account for new economic data, which could mean that additional funds may be provided beyond the $600 billion if conditions deteriorate.’

But how have the markets reacted to the QE2 announcement, and how likely are these plans to achieve the Fed's aims?

Broadly positive

The initial effect of the second QE tranche was dramatically volatile, with the Dow swinging 100 points during the first 15 minutes of the conference – but equities are now more settled, and overall the reaction appears to be favourable. The FTSE^® hit a two-year high shortly after the opening bell on Thursday, while the Dow finished 0.24% to the upside at Wednesday’s close. In forex the dollar weakened against all major currencies, and commodities improved.

This second round of QE has been on the cards for some time, ever since the minutes of the FOMC's October meet revealed that the majority of members were in favour of further asset purchases. The consensus of expectations had been for an initial $500 billion package spread over the next four to six months, with additional liquidity provided when needed. However, investors debated whether the programme would be fixed or open-ended, unsure if an exact amount would be tabled over a particular period or if month-on-month purchases were to be scheduled, aimed at fulfilling a particular economic exit condition.

The plans for QE2 announced by the Fed seem to have struck a balance of compromise between these possibilities. By extending the fixed phase to eight months, the overall value of securities purchased is higher than expected, while the monthly rate of spending should remain low enough to avoid arousing undue inflationary concerns. Also, by stressing the finite nature of the programme yet retaining a certain flexibility of review, the Fed is hoping to reap the benefits of a clearly-defined agenda while preserving the capability to adapt to any changes in the state of the economy.

The short-term reaction therefore has been positive for equities, but is this likely to extend to the medium/long term?

A risky strategy

Despite exceeding market expectations, the Fed has faced criticism that the asset purchase plans are still not high enough to have a significant effect on the US economy. Unemployment figures remain just south of 10% (a 26-year high), and with GDP struggling along at 2% growth over the last quarter, it seems clear that a radical upturn is needed. Many economists believe that $600 billion is simply not enough to make that happen.

In contrast, there are a number of voices suggesting that QE2 is in fact the wrong policy altogether. The initial programme was undertaken when the US economy was in severe trouble, and was broadly successful at pulling things back from the brink, but the suggestion is that policies such as this are more appropriate as weapons of last resort, rather than to kick-start a stuttering recovery.

The president of the Kansas City Fed, Thomas Hoenig, is a firm believer in this latter theory. The one dissenting voice at this week’s meeting, he has stated that further QE at this stage will cause dangerous asset bubbles which inevitably burst and lead to decline. His opposition from within the Fed is significant in itself, and could lead investors and analysts alike to wonder how robust the FOMC's predictions are. Any lack of confidence in the Fed and QE2 could potentially derail attempts to revive the economy, as market caution leads investors to hunker down and take shelter in the usual safe havens.

For the moment, though, the market reaction to QE2 has been a positive one, and this trend will probably continue for as long as the policy is seen to be working. Any prolonged weakness, however, could send sentiment through the floor and have grave long-term repercussions for the US recovery.

Take a position

Whether you see stock markets reacting positively to a raft of QE2 measures, or crashing due to a lack of confidence in the proposed asset purchases, with IG Markets you can back your judgement on a range of financial markets.

We offer from a one-point spread on the FTSE^® 100, from a two-point spread on Wall Street, and competitive prices on all other major global indices, as well as on individual shares and commodities. You can also trade CFDs on a wide range of major and exotic forex pairs.

If you are not already an IG Markets client you can apply online and open an account in minutes to start trading.

Updated: 04/11/10

The above comments do not constitute investment advice and IG Markets accepts no responsibility for any use that may be made of them.