Fed Ready for Another Round of QE?

Who wants more quantitative easing? The Fed does! At least that’s what recent comments from Fed members seem to suggest. The central bank has no plans to derail from its current pace of QE, which means it’ll probably keep pumping money into the economy. It ain’t called “QE4ever” on the streets for nothing yo!

According to San Francisco Fed President John Williams, the Fed has hit the sweet spot with its $85 billion per month purchases, which is composed of an almost 50-50 mix of mortgage-backed securities and long-term Treasuries.

Williams believes that these kinds of purchases have brought down interest rates and boosted the economy in the past, so why not stick with this tried and tested approach again? He claims that ending asset purchases after Operation Twist expires at the end of the year will only shock the markets and bring long-term interest rates back up… which is exactly what the Fed wants to avoid!

Judging by Fed Chairman Ben Bernanke’s speech earlier this week, it seems the Fed head himself sees eye-to-eye with Williams on this issue. Bernanke said he feels comfortable with current monetary policy, but the central bank is ready and willing to increase stimulus if the need arises.

Right now, the Fed is focused on making sure the economy gets back on its feet, so a highly accommodative policy is the way to go for the foreseeable future… or at least until we see major improvements in the job market and price stability.

Speaking of the labor market, it’s pretty clear that any developments in jobs growth are going to play a crucial role in how the Fed moves going forward.

The good news is that we’ve now seen 13 straight months of job gains of 100,000. Meanwhile, the unemployment rate has dropped from its peak of 10.2% in mid-2009, and now sits at just 7.9%.

According to Fed member Dennis Lockhart though, these simple metrics shouldn’t be the only basis for the Fed’s monetary policy decisions, as they may not give the full picture.
For example, while the unemployment rate has dropped, Lockhart points to slowing jobs growth from July to September as an indication that the labor market has failed to build any momentum.

In order to get a better gauge of improvement in the labor market, Lockhart believes we should look at other statistics. Some metrics that he believes would give a clearer picture of the state of the labor market are:

  • The number of people rejoining the labor force
  • Reductions in underemployment
  • Trends of labor statistics – looking for any strength or momentum

Depending on how the Fed reacts to any developments in the labor market over the next six months, I see two potential scenarios that can play out:

EUR/USD

Scenario A: If the Fed expresses any disappointment in the progress of the labor market, market participants may see this as a sign that more easing is just around the corner. This could mean even more dollar weakness.

Scenario B: If the labor market gains any momentum, especially under more specific metrics, it could cause the central bank to reconsider its position on some of its accommodative programs. This could lead to a dollar rally.

Whichever way it pans out, just make sure you pay extra attention to the NFP releases and the FOMC meeting minutes over the next few months, as it will help you establish your bias towards the dollar!

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