The Fed Doubles Down

The Fed is all-in.

In his press conference Tuesday, Ben Bernanke noted that the Fed has made two changes to its policy: first, they’ve changed the end-marker for buying bonds from a date to an economic indicator; and second, they’re changing operation “Twist” from a sterilized sell-bonds/buy-bonds program to a pure bond-buying spree.

With Operation Twist, they’ve been selling short-term notes and buying long-term bonds since September of last year in an attempt to flatten the yield curve and stimulate growth. It’s true that the curve has flattened since then; it’s unclear how much growth this has stimulated. But now they’ve changed their dance from the “Twist” to the “QE.” They’re adding $45 billion of Treasuries to the $40 billion per month of mortgage-backed securities that they’re already purchasing.

That’s $1 trillion in bond purchases per year that the Fed is undertaking. As one wag has said, you do that long enough and eventually you add up to real money. With the Fed adding to bank reserves an amount approximately equal to the federal deficit, we now know how big the Fed’s balance sheet is getting: so big!

And now we know when they will stop: when unemployment reaches 6.5%. Apparently, that is close enough to normal for the Fed to start acting normally. But we’re so far from normal now that between now and then, the Fed’s balance sheet should swell by at least two or three trillion dollars.

But will all this new money get out into the economy? So far it hasn’t. But maybe this time, after trying more the same input, we’ll get a different output.

Douglas R. Tengdin, CFA

Chief Investment Officer

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