Does the Fed Really Need to Do Another QE?

Whether you agree with it or not, reality is the Federal Reserve is likely to embark on another round of quantitative easing -- money printing -- in the coming months. And whether you agree with it or not, the logic behind such a move is that, by buying government bonds and mortgage securities, the Fed can drive down interest rates, enticing businesses and consumers to borrow, expand, refinance their mortgages, and whatnot.

But it's worth asking whether interest rates will actually fall if another round of QE goes into effect. There's good evidence that they won't. In fact, there's good evidence that they'll rise.

The Fed has already completed two rounds of quantitative easing, giving us clear examples of how interest rates have fared during periods when it's trying to push them lower. Neither is kind to the argument that QE helps lower borrowing costs. Quite the opposite:  

Interest rates have actually risen during both periods of QE.

There could be a couple of explanations for this. One is that all the money printing sparks fears of inflation, pushing interest rates up. But that's unlikely, since the overall trend of interest rates over the last four years has been down, down, down. Another is that QE actually did help boost the economy, and rising interest rates reflected optimistic investors willing to take more risk, abandoning the safety bunkers of Treasury bonds.

But there's another explanation that isn't as appreciated. In investing, you often hear the saw of "buy the rumor, sell the news." I think that's what we've seen with QE. Both rounds of Fed action, as well as the likely upcoming third bout, have been telegraphed loudly beforehand by the Fed to the point of being universally expected by investors well before they actually began. By the time actions were officially announced, investors looking to buy ahead of the Fed were already positioned. That's likely why interest rates have declined sharply in the months before QE official started. People bought the rumor and sold the news.

It's also likely why interest rates have plunged in recent months. A Reuters poll last week of primary dealers -- bankers who directly deal with the Fed -- put the odds of QE3 at 70%. Those expectations have almost certainly pushed interested rates down this year. Ten-year Treasury rates have plunged from 2.4% in March to 1.5% today.

If lower interest rates help boost the economy, there you have it. They're already here, driven by anticipation of QE3.

That sets up an interesting scenario. Does the Fed really need to do another round of QE if its benefits -- lower interest rates -- are already here? Four years ago, then-Treasury Secretary Hank Paulson said, "If you have a bazooka in your pocket and people know it, you probably won't have to use it." The quote, reflecting his hope that he wouldn't need to bail out the financial system, didn't work as planned, but there's real truth to the idea. If the Fed merely convinces the market that it's prepared to act, it can generate the kind of stimulus it hopes to accomplish without even acting. The language the Fed has used in recent press announcements -- promising to "provide additional accommodation as needed" -- is one of its most effective tools.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (11) | Recommend This Article (17)

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  • Report this Comment On August 07, 2012, at 6:15 PM, slpmn wrote:

    There has to be more economic theory behind Fed rate policy than - "Lower rates encourage borrowing, thus stimulating growth" doesn't there? God, I hope so. Sure, it's very easy to understand on an intuitive level, but I see some problems. 1) If that's the best the brightest economists in the world can come up with to guide national economies, wow. Just, wow. 2) It isn't working! Not here, and not in Japan.

    Personally, I think the effort to keep rates down may have as much to do about keeping federal borrowing costs low as it does with stimulating the economy. Issue bonds and have the Fed buy them. Actually, that reason makes a lot more sense to me than this fool's notion that dropping rates 50 basis points is going to stimulate anything.

  • Report this Comment On August 07, 2012, at 6:19 PM, neamakri wrote:

    Stop printing money!

    The FED has already spent my grandchildren's future, now they want to dig into my Great-grandhildren's future. WTF?

    When Ben gives (my tax) money to his banker and stockbroker cronies, how does that help even one jobless person? Answer: NOT.

    IMHO the absolute direct way for the federal government to make jobs is to actually spend on infrastructure; railrods, highways, power lines...you get the idea.

    Anything less is just being lazy and ignorant. Bernanke's idea that giving money to banks who then loan it to businesses who then hire people just vilolates the KISS principle. And it is pretty much a fact that the banks took the money and bought derivatives etc., plus gave themselves nice bonuses (with my tax money). WTF again?

  • Report this Comment On August 07, 2012, at 8:28 PM, xetn wrote:

    The other side of the coin of low interest rates is you can not earn a positive rate on saving. (Although the Keynesian ideal is to spend all income and save nothing.)

  • Report this Comment On August 07, 2012, at 9:13 PM, Acorn17 wrote:

    I think that there's another part to this that cannot be publically stated by the Fed, but is very real. By continuing to force rates down using QE this puts pressure on surplus nations like China, Japan, and Germany which all in various ways manipulate their currencies to maintain their exports (Germany by having the southern chunk of the EU effectively keep their currency lower than an independent Mark would dictate, Japan by taking advantage of a huge domestic savings rate by lending money to its own people at nothing and propping up inefficient conglomerates indirectly, and China by brazenly pegging it's currency and also giving depositors below inflation savings rates).

    What QE does is effectivly make the USD more competitive and pressures these surplus countries to take even more drastic measures (which long term hurt them more because in each case their trade surplus props are not sustainable long term) Think Great Depression levels of unemployment in Spain and other parts of Southern Europe because of they are uncompetitive with Germany and stuck in the Euro and the only fix is to balance this trade (lowering German exports by rising currency or debt forgiveness on an enormous scale for S. Europe -- both hurting Germany a LOT). In Japan same problem they have a debt to GDP ratio over 200% and an aging population ready to cash in and it is really expensive to prob up capital destrying industries with cheap monetary policy. And China, domestic debt is enormous and foreign reserves can't be used to repay it (it's RMB denomiated) and much larger than their foreign currency reserves anyway. Cheap monetary policy is what fuels their GDP growth and enormous amounts of capital destrying "investment" (empty cities). QE just fuels this because their currency becomes even cheaper due to the peg and the waste and domestic debt increases along with it.

    I think that QE might very well be a foreign policy tool to try and force a lowering of the US trade deficit over the long term by pressuring surplus countries that have manipulated trade terms through their domestic policies for so long. If this succeeds over the next decade it would be really bullish for the US domestically and I like to think that our leadership isn't as bone-headed as many like to make them out to be.

  • Report this Comment On August 08, 2012, at 1:06 AM, DJDynamicNC wrote:

    "(Although the Keynesian ideal is to spend all income and save nothing.)"

    I'm really looking forward to your quote from Keynes that actually backs that statement up.

  • Report this Comment On August 08, 2012, at 12:06 PM, astuber9 wrote:

    On August 07, 2012, at 9:13 PM, Acorn17 wrote:

    I think that QE might very well be a foreign policy tool to try and force a lowering of the US trade deficit over the long term by pressuring surplus countries that have manipulated trade terms through their domestic policies for so long. If this succeeds over the next decade it would be really bullish for the US domestically and I like to think that our leadership isn't as bone-headed as many like to make them out to be.

    That is an interesting idea and probably a big reason for QE3. However, I think SLPMN is the "most right" and it is just to keep the treasury rate down. To me it is scary that we are running such big deficits and still not getting any significant growth. And if we ever do get big growth like everybody wants obviously our borrowing costs go up and we cannot afford the interest on such a large principal. It is hard to be optimistic about the future considering that.

  • Report this Comment On August 08, 2012, at 2:49 PM, bobg55 wrote:

    Another view is to look at the effects of QE (Quisling Enrichment?). Without running the math I recollect that previous episodes of QE were followed by drastic increase in SOME commodity futures. Volatile future prices do NOT give businesses a basis for confident growth investment.

  • Report this Comment On August 10, 2012, at 1:58 PM, drborst wrote:

    @Acorn17, It isn't often that it happens to Morgan, but I think that comment was better than the article.

    drborst

  • Report this Comment On August 10, 2012, at 9:09 PM, ChrisBern wrote:

    What will be very interesting, and probably quite distressing when it happens, is how the Fed will ever execute an exit strategy from the sum of its QEs and twist programs. Currently the Fed balance sheet is around $2.9T large--prior to any QE3. Historical norms were more like $700B. So the Fed's balance sheet is a few TRILLION dollars higher than normal (and is leveraged over 50:1 by the way).

    So eventually the Fed will suck trillions of dollars back OUT of the economy when it sells back its accumulated bonds and assets. Does anyone see a point at anytime in the next even 5-10 years when the U.S. economy will be able to absorb that type of impact? Presumably this will also come at a time when the economy is in better shape, and therefore interest rates will be higher...which means the Fed will suffer hundreds of billions of dollars in capital losses on those bonds. Errr, I should say, the American TAXPAYER will suffer hundreds of billions of dollars in capital losses. And in the meantime how much are retirees, pension plans, and savers losing with the Fed's zero-interest policy? Other than ephemeral gains in the stock market, who exactly is the Fed trying to help here?

  • Report this Comment On August 10, 2012, at 11:44 PM, whyaduck1128 wrote:

    I'm starting to think that it doesn't matter to the Fed whether there's actually another round of QE ever, so long as they get continual attention from the media ABOUT it. In other words, Bernanke & Co. have become little more than quasi-Hollywood attention whores.

  • Report this Comment On August 12, 2012, at 8:57 AM, Darwood11 wrote:

    @Acorn17. Great commentary, particularly the brief statements about Europe. I think another QE is a real gamble, particularly with the deficits we are running. Who is going to blink first?

    If this were a movie, it would be like one of those implausible scenarios where dynamite is used to shore up a failing dam.

    In a few years we may very well be like Greece, as predicted by former Comptroller Walker.

    As for Paulson's quote, I agreed with that sentiment. However, having a bazooka will only telegraph action if it is also understood that one will use it. With the current political weakness, I'm not certain what other countries have decided about our policy makers and politicians.

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