Just as everyone and their momma expected, the Federal Reserve officially announced the beginning of QE3 at its latest FOMC statement last Thursday. In his speech, head honcho Ben Bernanke said that the Fed had had enough of the labor market’s struggles and that it was time to pull out the big guns to help boost employment.
Bernanke announced that the Fed will purchase 40 billion USD worth of debt each month, with the majority of the purchases being mortgage loans. Combining this with the on-going Operation Twist program, the Fed will now be purchasing 85 billion USD worth of bonds until the end of 2012. Furthermore, the central bank pledged to keep rates at low levels until mid-2015, extending its promise to keep rates at current levels until 2014.
The major surprise though, was that Bernanke didn’t put a limit to the amount of purchases. He stated that they would end the program not only when the labor market picks up, but when it’s alive and kickin’! Talk about committing to the cause!
In all my years of studying central banks, I cannot recall a time when a central bank based its monetary policy decisions with such a strong focus on employment. Normally, central banks lock in on price stability, which is the reason why inflation is such an important economic indicator.
I guess the August NFP report and the downward revisions to the June and July figures were the final straw indeed!
This combination of moves couldn’t have been worse for the dollar. Prior to the announcement, there were a number of potential outcomes based on different combinations of asset purchases, the length and amount of these purchases, as well as the any changes to interest rate policy.
Not only did the Fed announce QE3 and extend the period of low interest rates, but it kept its bond purchase program open ended and will only end it once the labor markets stabilizes. To put things into perspective, a recent study indicated a 500 billion USD bond purchase program would only reduce the unemployment rate by 0.1% over a year’s time.
This means that the Fed could end up spending over ONE TRILLION DOLLARS on bond purchases, and could easily be buying more by the time Apple releases the iPhone 6 in 2014!
That said, it’s no surprise the dollar dropped following the announcement:
By the end of the day, the USDX was trading nearly 50 cents lower from the levels it was trading at prior to the FOMC statement.
Going forward, there’s a good chance we could see dollar weakness continue.
The launch of QE3 is a double whammy for the dollar, as it weakens it on two fronts.
First, it makes the dollar fundamentally weaker, as more and more dollars are being flooded into the economy. Secondly, the launch of additional liquidity measures also lifts up risk appetite, as it aims to free up credit, push people to invest in businesses, stocks, and other higher-yielding investments. This just means even more weakness for the greenback.
The big question though, is whether this is all priced in or not. Take note that the dollar has been sliding over the past couple of weeks, as traders began positioning themselves for the possibility of QE3. Now that it’s all laid out on the table, will traders still continue to dump their dollars?
Hard to say but any way you look at it, the outlook for the dollar just got a whole lot dimmer.