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How the Fed's Easy Monetary Policy Will Impact Economic Activity, Asset Prices in 2013


With Operation Twist set to expire and because the Fed is out of short-term bonds with which to finance purchases, it is virtually assured that it will opt for outright purchases financed with printed money.

MINYANVILLE ORIGINAL Someone who knew a thing or two about math, equations, and probabilities reportedly once said that the definition of insanity was doing the same thing over and over again and expecting different results. This Wednesday Chairman Bernanke will hold court and the FOMC will likely decide on the future course of monetary policy, and more specifically, the scope of the QE policy, which by all accounts will be a continuation of the same large-scale asset purchase program.

With Operation Twist due to expire at the end of the year and because the Fed is essentially out of short-term bonds with which to finance purchases, it is virtually assured that they will opt for outright purchases financed with printed money. The question for investors is what, if any, impact a continuation of this uber-easy money policy will have on economic activity, and more importantly, asset prices in 2013.

In Sunday's New York Times Strategies section, Jeff Sommer addresses The Next Move for the Fed:

Since 2008, the Fed has engaged in three rounds of unconventional large scale asset purchases, known as quantitative easing. In the first round, QE1, from November 2008 to March 2010, it bought $1.75 trillion in long-term Treasuries and other securities, the Richmond Fed said. In QE2, from November 2010 through 2011, it bought $600 billion in long-term Treasuries. QE3 has been under way since September 2012, with the Fed buying $40 billion each month in mortgage-backed securities.

Now, said Ned Davis Research in a report last week, the Fed is likely to replace Operation Twist with purchases of Treasuries, perhaps in the $45 billion a month range, bringing its total monthly purchases to $85 billion.

Quoting Kathy Jones, fixed income strategist for the Schwab Center for Financial Research:

This is all about signaling – about using language and numbers to persuade investors, consumers and people in business that money will be cheap and plentiful for a long time to come.

During the worst phase of the financial crisis, the Fed's extraordinary expansive monetary policy was intended to prevent the economy from plunging into a possible depression. These days, it is intended to help restore vigor to the economy, with mixed results so far. The November survey of Blue Chip Economic Indicators, for example, showed that economic forecasters expected gross domestic product growth of only 1.7 percent in the fourth quarter, along with 2 percent annual growth in 2013.

Saying the results have been mixed is putting it lightly. I would say you would be hard-pressed to find any evidence that QE has worked at all. In fact I think you could argue QE hasn't even been successful in lowering long-term interest rates or raising stock prices to levels that they otherwise would be if there were no intervention.

If QE were able to raise stock prices via reflation or a lower discount rate, you would assume that would be in the form of a multiple expansion -- but that hasn't happened. Multiples have, at best, been flat if not contracting as the S&P (INDEXSP:.INX) has rallied 100% off the lows. In 2007 when the S&P was at these same levels in the low 1400s, the price-to-book ratio was closer to 3x book vs. today's level of 2.15x book. Today's S&P 500 book value of $662.44 is the highest as a ratio to nominal GDP in over a decade, yet the multiple for that equity is near the lowest over the same period.
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