On Thursday, the U.S. Federal Reserve Chairman announced plans to provide more stimulus because: 1) it was concerned that the economic recovery may be at risk and 2) U.S. employment trends need to improve. This third round of quantitative easing (QE3) promises to 1) keep interest rates low until at least the middle of 2015 and 2) take the unprecedented step of pursuing open-ended stimulus efforts (often interpreted as “printing money”) until the employment situation “substantially” improves.
On Friday, investors confronted both positive and negative news as:August industrial production unexpectedly declined by 1.7%, with weakness in automotive production and other manufactured goods and 2) consumer sentiment improved during August with the Thomson Reuters/University of Michigan index unexpectedly increasing to 79.2 from 74.3. Against this backdrop, risk assets such as equities and commodities had strong positive moves, while stress in many credit markets continued to decline.
At the same time, broad debates about the Fed’s unprecedented actions are focusing on topics such as: 1) does the Federal Reserve have special insights into increasing economic weakness, 2) are its actions politically motivated to assist in President Obama’s re-election and reduce Chairman Bernanke’s chances of losing his job and 3) does the Fed have the capacity to improve employment trends?
While the Federal Reserve hopes to reduce the risk adverse behavior of consumers, business leaders and lenders, the open-ended and unprecedented nature of its actions may also introduce more uncertainty into the markets. Regarding the potential to improve employment trends, with many businesses continuing to spend on new equipment and software to improve operational efficiencies, rather than hiring new employees, it seems that fiscal policy (by Congress), rather than monetary policy (by the Federal Reserve) may be a more constructive approach (assuming Congress can get its act together). Regarding political motivations, this is a presidential election year – everything is political. Regarding the tone of the markets, this week’s actions by the Fed may continue to improve the mood among investors, but let us not assume that “open-ended stimulus” also means “no risk investing”.