I’ve discussed this a couple of times in the past few weeks, but the idea that the Federal Reserve will engage in a third round of quantitative easing (QE3) sometime in early 2012 is getting more and more press these days. In today’s Wall Street Journal, Kelly Evans wrote an interesting article about the possibility of the Fed purchasing mortgage-backed securities in the first quarter.
The article says that while recent economic reports have been strong the possibility that certain U.S. budgetary cuts and the ongoing European debt problems could pose a threat to our painfully slow economic recovery.
A recent Bloomberg survey of Treasuries dealers showed that 16 of 21 respondents believe that the Fed will engage in asset purchases in the first quarter. The median prediction amongst these dealers is that the Fed will purchase $545 billion worth of mortgage bonds in the coming year. The Journal article says that a source from Moody’s believes that Fed action could cause rates on 30-year fixed rate mortgages to fall to 3.5-3.75%. The impact on rates would ultimately be tied to the size of the asset purchase program, and that is fairly difficult to predict.
I guess the crucial question here is how likely is it that the Fed will take action? It appears that the markets feel that the Fed will purchase mortgage backed securities. Recently, the spread between mortgage backed securities and treasury bonds has widened significantly, and this could signify that traders are anticipating Fed purchases.
Further, several Fed Presidents, including William Dudley, Charles Evans, and John Williams have all implied or outright stated in recent speeches that an additional round of easing could be necessary, and that MBS purchases in particular would help the housing market.
We should probably keep an eye on the next few months worth of economic data, in particular inflation figures. As long as inflation is under control, asset purchases remain a possibility. If inflation starts to increase significantly, further asset purchases are probably off the table.
The next couple of FOMC meeting occur on December 13, January 24-25, and March 13. If the Fed is going to change monetary policy, it would do so at one of these meetings. Stay tuned…
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