Forecasting Fed Policy On QE 3

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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The Federal Reserve appears to have telegraphed its thinking on its third round of Quantitative Easing, QE3, in the recent remarks of Fed Vice Chair Janet Yellen and San Francisco Fed president John Williams.

We forecast unemployment to arrive at the Fed’s target of 6.5% by Q2 2015 and the housing market recovery to be completed also about that time. Gross Domestic Product (GDP) is expected to range between 0.5% and 2% in 2013.

It must be noted here that though government budget cuts affect market sentiment by lowering the GDP as in Q4 of 2012, except in defense cuts in weapons systems and related procurements, sequester furloughs and any government pull back on government employment should have little effect on overall unemployment beyond the psychological.

Targeting unemployment rate of 6.5% and inflation of 2%, the Fed is preparing to simultaneously wind down its $45 billion-a-month long-dated treasuries and $40 billon-a-month mortgage backed securities (MBS) purchases gradually by mid-2015 beginning mid-2013. In particular, QE3 will not be necessary once the housing market recovers to self-sustainability without external support.

The Fed will completely end QE3 by mid-2015 and stay between zero and 1/4 percent federal funds rate after that, providing inflation projections remain contained below 2.5%.

In the aftermath of the 2007-2008 crisis the Fed and the United States have not adopted policies to jumpstart growth and employment creation with very large projects. Instead, reflationary monetarism at the Fed was accompanied by less than ambitious spending on patchy public works projects on the fiscal front. The window for making amends is closed without another recession in the United States.

Amends are structural reform of government and government spending given the national debt, and industrial policy by monetary policy to provide the much needed funds for very large projects to jumpstart growth and create jobs.

It is clear after the “London Whale” debacle of JP Morgan Chase and US Treasuries sell off after the weakening of the yen that shadow banking, as Fed Chairman Bernanke cautioned and as a recent New York Fed paper pointed out, will continue to play a critical role in everything from winding down QE3 to the next crisis.

The mother’s milk of engineered crises have become a way for hedge funds and the like to keep the easy money party from the Fed going, a behavioral pattern the Fed must preempt if it is to succeed in smoothly ending QE3 and easy money policies.

The government needs to give itself and the markets better direction.


About Chandrashekar (Chandra) Tamirisa
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