QE1.1 : NOT EASING BUT ABSENCE OF TIGHTENING / THE FINANCIAL TIMES ( RECOMMENDED READING )

QE 1.1: Not easing but absence of tightening

By James Mackintosh

Last updated: August 11 2010 12:32

It has already been dubbed QE2 by the markets. But the US Federal Reserve’s renewed quantitative easing – or buying of assets – is really QE1.1, at most. The basic principle is that the Fed will reinvest the proceeds from its last round of quantitative easing, in March last year, into Treasury bonds.

This is not so much actual easing as an absence of tightening. The Fed’s plan had been to let its holdings roll off as they matured, reducing its balance sheet gradually. Given that it has a balance sheet stuffed with $2,054bn of government bonds and mortgage-backed securities, that sounds like a big number.

In fact, relatively little money may be reinvested. Only $132bn (£83bn) of the Fed’s holdings mature within a year, and since the start of July the Fed’s holdings have shrunk by just $6bn – small change in the Treasury markets.

By keeping its balance sheet stable, rather than shrinking, it is true that some marginal upward pressure on bond yields will be removed. The Fed hopes that this will anchor bond markets, lowering rates on longer-term bonds further and so reducing corporate and individual borrowing costs.

Unfortunately it is not clear that this is addressing the right problem. Creditworthy borrowers have already been able to get loans at historically low interest rates. IBM, for example, raised money at just 1 per cent in the corporate bond market last week, while 30-year mortgage rates are also at all-time lows. The difficulty is that many do not qualify for these loans. Figures on Tuesday showed confidence at small businesses remains terrible, while remortgages – which should give instant monthly savings to homeowners – are running at fairly low levels.

What really matters here is not what the Fed has done, but what it is signalling: deflation is indeed a worry. More important, if the economy continues to struggle, further easing may be on the way. That prospect is what is moving the markets.

Copyright The Financial Times Limited 2010.