QE2

From Bloomberg:

Fed Risks Its Credibility on a Bowlful of Mush

It’s all over but the voting.

After all the speeches and the posturing, after the trial balloons and the press leaks, the Federal Reserve probably will announce another round of quantitative easing at the conclusion of its two-day meeting Wednesday.

The Fed embarks on this program with the intention of lowering yields on long-term Treasuries, which in turn will bring down mortgage rates and corporate bond yields. Surely there must be two or three households holding back on a home purchase because the 30-year mortgage rate at 4.2 percent is too onerous.

If QE1, which entailed the purchase of $1.4 trillion of agency debt and mortgage-backed securities (in addition to $300 billion of Treasuries), was about credit easing, QE2 then is about prices. I have yet to hear any Fed official talk about Q, about increasing the quantity of money -- specifically bank reserves -- which is where quantitative easing gets both its name and its heft.

Either the Fed is operating under a misconception about how QE2 will reduce unemployment and raise inflation, or it has failed to communicate the transmission mechanism to the public. Neither is a plus.

It would be better to stabilize inflation expectations in the 1 percent to 2 percent range, the Fed’s implicit target since 1996, and provide a coherent framework for understanding how its actions affect the economy and prices.

Under Bernanke, monetary policy has become enamored with the idea that “communication and expectations adjustment is where all the leverage is,” says Timothy Duy, director of the Oregon Economics Forum at the University of Oregon in Eugene.

If the Fed has failed to communicate its framework for fighting deflation, as Goodfriend says, and if expectations aren’t your cup of tea, no wonder you’re nervous. Bernanke is headed into uncharted waters with no compass, no radar, and no stars to guide him.

The good news is he’s got plenty of fuel. The bad news: His only rations are gruel.

Comments:

I will be most interesting to see how the market reacts to QE2 particularly with midterm results coming in about the same time.
My estimation is that QE2 will have minimal impact on prices, it will be like pushing on a string.
The area of concern, in my view, is the reaction of the bond market.
How long will bonds tolerate recklessness?
How long will the markets permit these irrational, ill-conceived actions to continue?
One technical indicator in bonds recently showed a double top.
When we consider the $14 trillion economy of the United States, the $13.5 trillion debt (not including unfunded liabilities) which is quickly edging toward 100% of GDP, the 9 to 10% of GDP budget deficits that manages to boost the economy by 2 or 3% (an overall net loss of 7% or so), we should only have one question.

How long?