Before getting into our main topic for today, the Labor Department reported this morning that the unemployment rate for October edged slightly lower to 9.0% from 9.1% for the previous three months. The report noted that non-farm payrolls climbed by 80,000 last month, more or less in line with expectations. We need monthly job creation of 150,000-200,000 just to offset the increase in the population.
As for our lead topic today, the Fed Open Market Committee (FOMC) convened on Tuesday and Wednesday to set monetary policy for the next few months. Each time the FOMC meets, it issues a policy statement afterward. Wednesday’s policy statement was almost a carbon-copy of the September statement, but with a few interesting twists.
You may recall that prior to the September FOMC decision, it was widely anticipated that the Fed would announce yet another round of “Quantitative Easing” or QE3. The Fed didn’t. Instead it announced that it would embark on a program of reshuffling its massive securities portfolio by switching short-term maturities to long-term securities. This process is called “twisting.”
The intended effect was to lower long-term interest rates even further, thereby providing some relief in the home mortgage market. While trading short for long did not involve buying more net securities (ie – QE3), it was reasonably well accepted as “doing something.” So, how has it worked so far? The following chart illustrates that the so-called “Operation Twist” has thus far had little effect on long-term rates and mortgages.
As you can see, 30-year mortgage rates dipped initially after the Fed’s announcement in late September (vertical green line), from just above 4% to just below 4%. But then rates moved back above 4% again, and at the end of October were hovering right at 4%. The net result is that the Fed’s Operation Twist has had little, if any, meaningful effect, at least so far.
In this week’s FOMC policy meeting, the Fed voted to continue Operation Twist despite its lack of effectiveness in lowering long-term interest rates. And it continued to advance its policy of keeping short-term interest rates near zero percent until at least the middle of 2013.
Shuffling the Deck Chairs at the Fed
The FOMC consists of 12 voting members, including the Fed Chairman, currently Ben Bernanke. The FOMC members are typically made up of a combination of “hawks” – those who favor more conservative monetary policy, and “doves” who favor more liberal policy. In late September when the Fed voted to implement Operation Twist, there were three hawks that voted to oppose the policy.
Yet this week, all three of the so-called hawks that voted against the policy in late September voted in favor of continuing Operation Twist this time around. I can find no information that hints of why this change of mind occurred. We can only assume that Chairman Bernanke succeeded in some arm-twisting since the September FOMC meeting.
Most surprising of all in this week’s vote was that one FOMC member who is a dove voted against continuing Operation Twist. That was Chicago Federal Reserve Bank President Charles Evans, the lone dissenter, who called for more quantitative easing (QE3) now to support the fragile economy.
So what are we to glean from all this? The growing consensus is that the FOMC is migrating toward another round of Quantitative Easing (QE3). Why? Bernanke was able to switch three hawks over to his side with this week’s meeting. And one dove, Charles Evans, voted against continuing Operation Twist in favor of more QE now.
The next meeting of the FOMC will be on January 24-25, and it remains to be seen if QE3 will be enacted at that time. That will depend, of course, on the economic reports between now and then. We had a little economic encouragement of late in that the advance GDP report for the 3Q came in better than expected at 2.5% (annual rate), up from 1.3% in the 2Q.
So what does this mean, if anything, for us as investors? Here’s what. The net result of QE1 and QE2 was a big run-up in stock prices. If we’re on track for QE3 in late January of next year, then it would be reasonable to expect yet another stock market surge early next year. Of course, the devil is always in the details (ie – how large might QE3 be, etc.).
The point is, the Fed seems to be positioning for more QE next year. That might mean that stocks break out of the broad trading range of this year to the upside early next year. But that all depends on what happens with the European debt crisis and whether or not Greece defaults. I’m not optimistic. That’s why I have the bulk of my money in the equity markets invested with professionals who can go long or short or just sit in cash in money markets.
Have a great weekend everyone!
Sorry, comments are closed for this post.