If you are looking for an edge in terms of Thursday's highly anticipated Fed announcement, the statements leading up to the announcement of QE2 in 2010 are an excellent place to start. Thus far, 2012 has not strayed far from the 2010 QE script, meaning we believe it is only a matter of time before QE3 is announced.
QE2: Winning ETFs
Should the Fed announce another round of asset purchases as expected, it may be handy to know the following ETFs were the big winners during QE2: silver (SLV), oil equipment (IEZ), oil services (OIH), oil/gas equipment & services (XES), oil & gas exploration & production (XOP), energy (XLE), coal (KOL), metals & mining (XME), natural gas (FCG), global energy (IXC), agriculture (RJA), small cap growth (IWO), Russia (RSX), semiconductors (SMH), and private equity (PSP).
QE Script 2010
In 2010, the Fed used both Jackson Hole and a formal Federal Open Market Committee (FOMC) statement to set the table for the announcement of QE2 in November. The Fed language from points A, B, and C are summarized later in this article. Point A is Jackson Hole 2010, point B is a Fed statement that "disappointed" the markets since QE was not announced, and point C is the formal announcement of QE2. The chart of the S&P 500 allows you to see how stocks reacted at points A, B, and C.
Below are the key portions of Ben Bernanke's 2010 Jackson Hole speech, which are followed by this year's remarks for comparative purposes.
In many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow and joblessness remains too high.
This list of concerns makes clear that a return to strong and stable economic growth will require appropriate and effective responses from economic policymakers across a wide spectrum, as well as from leaders in the private sector. Central bankers alone cannot solve the world's economic problems. That said, monetary policy continues to play a prominent role in promoting the economic recovery and will be the focus of my remarks today.
I will conclude by discussing and evaluating some policy options that the FOMC has at its disposal, should further action become necessary.
Overall, the incoming data suggest that the recovery of output and employment in the United States has slowed in recent months, to a pace somewhat weaker than most FOMC participants projected earlier this year.
The prospect of high unemployment for a long period of time remains a central concern of policy. Not only does high unemployment, particularly long-term unemployment, impose heavy costs on the unemployed and their families and on society, but it also poses risks to the sustainability of the recovery itself through its effects on households' incomes and confidence.
Notwithstanding the fact that the policy rate is near its zero lower bound, the Federal Reserve retains a number of tools and strategies for providing additional stimulus. I will focus here on three that have been part of recent staff analyses and discussion at FOMC meetings: (1) conducting additional purchases of longer-term securities, (2) modifying the Committee's communication, and (3) reducing the interest paid on excess reserves.
A first option for providing additional monetary accommodation, if necessary, is to expand the Federal Reserve's holdings of longer-term securities. As I noted earlier, the evidence suggests that the Fed's earlier program of purchases was effective in bringing down term premiums and lowering the costs of borrowing in a number of private credit markets. I regard the program (which was significantly expanded in March 2009) as having made an important contribution to the economic stabilization and recovery that began in the spring of 2009.
I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions. However, the expected benefits of additional stimulus from further expanding the Fed's balance sheet would have to be weighed against potential risks and costs
Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally.
Jackson Hole 2012: The Case For More QE
If you read Ben Bernanke's entire Jackson Hole 2012 speech, it is unquestionably pro-QE. Below are some key portions from the Fed Chairman's August 31, 2012 remarks:
Tobin suggested that purchases of longer-term securities by the Federal Reserve during the Great Depression could have helped the U.S. economy recover despite the fact that short-term rates were close to zero, and Friedman argued for large-scale purchases of long-term bonds by the Bank of Japan to help overcome Japan's deflationary trap.
Large-scale asset purchases can influence financial conditions and the broader economy through other channels as well. For instance, they can signal that the central bank intends to pursue a persistently more accommodative policy stance than previously thought, thereby lowering investors' expectations for the future path of the federal funds rate and putting additional downward pressure on long-term interest rates, particularly in real terms. Such signaling can also increase household and business confidence by helping to diminish concerns about "tail" risks such as deflation. During stressful periods, asset purchases may also improve the functioning of financial markets, thereby easing credit conditions in some sectors.
How effective are balance sheet policies? After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve's large-scale purchases have significantly lowered long-term Treasury yields.
Three studies considering the cumulative influence of all the Federal Reserve's asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.13 These effects are economically meaningful.
Importantly, the effects of LSAPs (large-scale asset purchases) do not appear to be confined to longer-term Treasury yields. Notably, LSAPs have been found to be associated with significant declines in the yields on both corporate bonds and MBS.14 The first purchase program, in particular, has been linked to substantial reductions in MBS yields and retail mortgage rates. LSAPs also appear to have boosted stock prices, presumably both by lowering discount rates and by improving the economic outlook; it is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC's decision to greatly expand securities purchases. This effect is potentially important because stock values affect both consumption and investment decisions.
Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.
Overall, however, a balanced reading of the evidence supports the conclusion that central bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks.
QE Table Setting 2010
Since QE2 winners began moving rapidly higher after Jackson Hole 2010, many forget QE2 was not formally announced until the November meeting. The Fed's September 2010 meeting "disappointed" the markets, but it did help set the table for QE2. Below are some key portions from the Fed's September 21, 2010 statement:
Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months.
The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.
Was The QE Table Set In August 2012?
Key portions of the Fed's August 1, 2012 statement are shown below, allowing you to compare them to the "table setting" statement from September 2010:
Information received since the Federal Open Market Committee met in June suggests that economic activity decelerated somewhat over the first half of this year. Growth in employment has been slow in recent months, and the unemployment rate remains elevated.
Inflation has declined since earlier this year, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee anticipates that inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate.
The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.
What Does A QE Announcement Look Like?
Below are portions from the Fed's November 3, 2010 statement, which formally kicked off QE2:
Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow.
Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
What happens on Thursday may not matter in the longer term since the next round of QE is probably only a matter of "when", not "if". If you read the Fed statements from 2010 and 2012, it is relatively easy to see why Wall Street is confident QE3 will arrive sometime in the not too distant future. We share the Street's confidence on "if", but also respect the "when" is more difficult to pin down. We are positioned for QE with exposure to precious metals (SLV), energy (XOP), and commodities (XME).
