Fed takes another try at quantitative easing; money managers react

Fed Chairman Ben Bernanke
Fed Chairman Ben Bernanke

The Federal Reserve on Thursday announced it will begin a third round of quantitative easing and will keep the federal funds rate at the zero to 0.25% target range at least through mid-2015.

The Fed will purchase an additional $40 billion a month in agency mortgage-backed securities on an open-ended basis that will continue if the “labor market does not improve substantially,” according to a statement Thursday at the end of the Federal Open Market Committee’s two-day meeting.

Agency MBS purchases will begin Friday and are expected to total $23 billion over the rest of September.

Fed Chairman Ben Bernanke said at a news conference Thursday there was no specific number in mind for job improvement to end the MBS purchasing. “We don’t have a single number that captures that,” he said in a news conference. The Fed is looking for unemployment to come down in a substantial and consistent way.

In the statement, the FOMC said it was “concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market committees.”

It will also continue Operation Twist, which extends the average maturity of the Fed’s Treasury holdings, through the end of this year and is maintaining its policy of reinvesting principal payments from agency debt and agency MBS in agency MBS. The actions combined will increase the Fed’s holdings of longer-term securities by about $85 billion a month through the end of the year.

Michael Dueker, chief economist at Russell Investments, said the announcement of QE3 was “entirely warranted” as an attempt to get the economy moving again.

“The only quibble I might have is I thought they would announce a little higher amount than $40 billion, maybe more like $60 billion,” Mr. Dueker said in a telephone interview.

Matthew Eagan, vice president of Loomis Sayles & Co. and co-portfolio manager of the $21 billion Loomis Sayles Bond Fund, said the announcement was not surprising with economic data weakening and “deflationary red lights flashing in the economy.”

“What sealed the deal for this was the horrendous jobs numbers from last Friday,” Mr. Eagan said in a telephone interview.

Mr. Eagan expects QE3 to go on for “quite some time” as 2013 growth is expected to be similar to this year. He added that fundamentally the announcement does not change much, and that ultimately politicians need to make decisions to improve the labor outlook. He thinks equity markets will get a lift and the dollar will weaken, but much of the announcement was already priced into the markets.

“Get rid of the uncertainty so people can plan for the future and hire confidently,” Mr. Eagan said.

The Fed is taking these actions because it is worried about the pace of economic growth and is using these measures to quicken the recovery before moving to raise interest rates, said Zach Pandl, senior interest-rate strategist at Columbia Management. He added that long-term interest rates will have the tendency to rise for the time being as the economy recovers while short-term rates will remain at historic lows.

There is likely to be more clarity on when the Fed plans to end its MBS purchasing when the meeting minutes are released in three weeks, but purchases are expected to go well into 2013, Mr. Pandl said in a telephone interview.

The markets responded to the Fed’s announcement with a big gain. The Dow Jones industrial average closed up 206.51, or 1.55%, at 13,539.86; the S&P 500 rose 23.43, or 1.63%, closing at 1,459.99; and the Nasdaq composite was up 41.52, or 1.33%, to close at 3,155.83. All numbers are preliminary.

The Dow ended the day Thursday at its highest level since Dec. 26, 2007, while the S&P 500’s close was the highest since Dec. 31, 2007.