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Quantitative Easing – A New Policy?

Discussion in 'Forex Articles' started by dojit, Dec 21, 2008.

  1. dojit

    dojit Private

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    Quantitative Easing – A New Policy?

    After a rocky and suspenseful week due to the auto-industry saga, the White House stated on Friday that it is prepared to extend $13.5 billion in loans to the various auto-manufacturers, with an additional $4 billion to be supplied in February. Investors welcomed the good news but the markets didn’t rally!!!!

    Over the last couple of months confidence among investors has been battered, as a series of events have increased the turmoil. From a housing bubble to a credit crisis, more and more financial firms are on the verge of bankruptcy, while other firms are being prosecuted for abusing the financial system. The Fed and other banks have done their utmost to control the situation as economic growth has gone up the spout, while inflation has dropped due to the lack of consumption. Crude oil, a leading commodity, has dropped by magnitude proportions due the current slowdown, now trading just above $40, down by over 59% this year alone. Even though OPEC has recently slashed its output by 2.2 barrels per day, the lack of supply just doesn’t seem to be helping the price of crude to evaluate, due to the recent decrease in demand.
    In addition, the Bank of Japan cut its key interest rate to 0.1% last week, bringing its rate down to the lowest yielding among all the major economies. Furthermore, the U.S slashed its rate by 0.75% bringing its key fund rate down to merely 0.25%

    Many traders are now questioning what is going to be the Fed’s next move. What could be the solution, when central banks have reduced their rates by such extremes, that there is no more room left for further cuts?
    Even though stock markets have stabilized over the last couple of weeks, the lack of confidence in the markets is not driving investors out of safe haven. The situation has reached such levels severity that investors would rather grab U.S short term bonds than long term ones, out of fear that the U.S will not be able to pay back its loans. Yields on short term bonds have diminished to ridiculous levels while long term bonds are presenting enormous returns, due to market confidence. The Fed has only recently reduced its rates by an unexpected 0.75%, hoping that it will spark a major rally, but it hasn't happened yet as money is still seeking safe-haven.
    With a central bank rate of only 0.25% and confidence down the drain, the Fed has now stated that it intends to buy back long term bonds, in hope that lower yields will present a non-attractive environment for bonds while easing the credit market, especially as loans and mortgage rates are often calculated according to long term government bonds.
    By purchasing commercial bank bonds, the Fed is hoping to increase the money supply of banks- circulating money yet again throughout the economy.

    Quantitative Easing – A situation where a central bank reduces its interest rate to near zero, while flooding the market with money (increasing the money supply), to encourage private lending.
    The Bank of Japan carried out quantitative easing for a 5 year period to try to stimulate their economy. From 2001 to 2006 the BOJ purchased trillions of Yen worth financial securities as they tried to flood the markets with excess liquidity. This policy, which took over 5 years, finally paid off as inflation levels in Japan began to rise while more money became available for borrowers.
    Even though Quantitative Easing might be one way to deal with the current situation, one has to remember that flooding the markets with additional money will have various consequences, especially due to the linkage between the different markets and due to current lending conditions;
    1) The Fed is providing more money to Commercial banks that have curved their lending conditions= excess amount of money is just lying around.
    2) How do you think the Dollar’s value will hold up as the Fed floods the markets with more Dollar notes?
    What worked for one economy will not necessarily work for another and to date, analysts are stating that despite the recent policies of central banks further fiscal actions will be needed to stimulate the economy- meaning that not all solutions are monetary ones.

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