The talk of the forex town a couple days ago was a report by the Wall Street Journal (WSJ) that claimed the Fed is considering a new type of bond-buying program. It’s called sterilized quantitative easing, folks!
If rumors are proven to be true, then the Fed will score some serious creativity points with this plan as it will be a new and novel approach for the central bank. As you may remember from 2008 to 2011, the Fed’s previous rounds of quantitative easing involved the simple act of printing money to buy Treasury securities and mortgage debt.
But according to the WSJ, the Fed’s new plan is to print new money to buy U.S. bonds and borrowing back that same money for short periods at low rates. With this approach, the Fed can reap the benefits of quantitative easing without affecting the monetary base and triggering a rise in inflation, which are often considered drawbacks of QE.
This, my friends, is why this approach is called “sterilized” quantitative easing. It basically sterilizes quantitative easing of its negative effects. Neat, huh?
Similar to Operation Twist, such a move would result in larger long-term bond holdings for the Fed and larger short-term holdings for banks and private investors. Its ultimate goal is to encourage business investment and consumer spending while keeping inflation in check.
So why was this a big deal for the markets? Well, if you recall what Fed head Ben Bernanke said last week, you would’ve probably brushed off the possibility of QE3 in the near future. This new type of bond-buying program, however, led many to think that another set of easing measures could be in the cards.
Keep in mind though that the Fed has neither confirmed nor denied the WSJ’s claims, which means that it’s all speculative for now. After all, Big Ben did note several improvements in the U.S. economy lately, particularly in the labor market, suggesting that further easing isn’t necessary yet.
Come to think of it, Fed officials probably decided to stay mum on the matter for now since they’re in a wait-and-see mode themselves. The decision to loosen up monetary policy will probably ultimately depend on whether or not the U.S. is able to withstand recent economic threats, such as rising oil prices or the euro zone debt crisis.
As I mentioned in one of my old articles about the effect of rising oil prices on the global economy, central banks like the Fed might have a tough time justifying additional liquidity measures since these might aggravate inflationary pressures. Remember that one of the primary goals of central banks is to maintain price stability, and the last thing they’d want to do is let inflation spin out of control.
To make things even more complicated, the worsening debt situation in the euro zone might force central banks around the world to go for another set of coordinated easing measures. Word through the grapevine is that a Greek debt default might be inevitable and that Portugal could ask for more bailout funds soon.
As I always say, these are unprecedented times and it’s tough to predict what will happen next. For now, it’d be best to stay updated by reading my buddy Pip Diddy’s Daily Forex Fundamentals to figure out whether the Fed is inclined towards more easing or not. Do your homework yo!