The latest in my recent posts for the CFA Institute. I think overall I am more bullish on the actual economic impact that QE has had via the refinancing channel (it’s very material), but maybe more skeptical on how perilous of a hole the Fed is digging itself into by buying so much of the Agency MBS market. I obviously think the ramifications and understanding of QE are crucial in the day and age in which we live. I’ll post an excerpt below and read the full version on the CFA’s website. Thanks!
ther risky asset classes as the prices of these bonds rise (yields fall). To put the purchases in perspective, it’s important to understand the monthly production of agency MBS.
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At the moment, about $125 billion of agency MBS (mortgages backed by Fannie Mae and Freddie Mac) are produced each month. Through Operation Twist and the reinvestment of previous rounds of QE, the Fed is already purchasing ~$30 billion of bonds per month.
Add in the $40 billion per month that was just announced for the third round of QE (QE3), and the Fed is purchasing ~$70 billion of the ~$125 billion that is produced each month. Purchasing nearly 60% of the gross issuance of MBS obviously has a major impact on the market and forces investors into other asset classes.
The data support the clear benefits that QE has had and will continue to have in certain segments of the economy. Nevertheless, unemployment is persistently high, inflation is relatively tame, and wage growth is anemic. How much will this iteration of QE really be different from QE rounds in the past?
Nomura’s Richard Koo, creator of the balance sheet recession theory, pointed out that monetary policy has lost its effectiveness when the private sector is deleveraging (or minimizing debt), despite near zero interest rates. More and more signs of this deleveraging are appearing in the U.S. economy. While major corporations shrewdly lock in long-term debt at record low rates, average Americans are reducing their mortgage terms. Instead of cutting their term in half and keeping the same monthly payment, they could be investing and spending the savings. Although I’m not saying people should be doing this, the psychology of decision making in the United States promotes deleveraging in many respects.
By David Schawel, CFA of Economicmusings