FED MINUTES TELL MAJORITY WANTS QE3, BUT CONVICTION FOR QE3 REMAINS HESITANT

Speculation on a third round of Federal Reserve Bank quantitative easing, or QE3, found much more certainty in its occurrence. On Wednesday, Federal Open Market Committee (FOMC) minutes were released revealing existing Federal Reserve sentiment. Based on Fed discussions, QE3 looks to be a matter of time rather than “if”.

Quantitative easing amounts to the Fed increasing monetary supplies by buying government securities such as treasuries from banks. Banks thereby receive an infusion of cash. Then, expectations are for banks to lend their new cash. Past experiences have revealed, however, increases in commodity values and equities. Also realized in past QE is treasury prices decline and yields increase while the dollar falls due to flooding liquidity.

Oil prices, being driven in dollars, are fraught with a balance between cheapening U.S. dollars and increasing demand driven by comparatively cheap dollars.

With oil prices having been in decline for a considerable period, starting certainly last April, increases in U.S. dollar isn't a cause, U.S. dollar has increased but not to a degree explaining crude price declines. Rather, supplies have increased against a decline in global demand, simple. Implied is further QE might not ultimately drive up demand for oil, and thereby U.S. or global production. Rather, QE3 could raise petroleum prices through speculation driven by past pricing experience, only for economies to ultimately see a further decline in demand and production due to price.

Data also reveals QE's association with increases in GDP, here in the U.S. and abroad. It can have a positive influence. But that influence is experienced only during the period of exceptional easing operations. Once it ends, we return to what existed otherwise. Similarly, cash infusions brought by QE certainly create reserves to be used later, during better economic times. Suggested is potential inflation later once economies improve. However, when will economies improve. Recovery is now a new normal.

Saying this, FOMC minutes of Wednesday reveals QE3's likelihood, but not its conviction. Where minutes say “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” Other comments, apparently in the minority, point out QE3 risks.

According to FOMC minutes, “A few participants were concerned that an extended period of accommodation or an additional large-scale asset purchase program could increase the risks to financial stability or lead to a rise in longer-term inflation expectations.”

Through FOMC minutes, alternatives to QE3 were addressed but overall rejected. Namely was discussion on other central bank activities. ECB's zeroing of interest charged on deposits was considered, but rejected. ECB's efforts are conducted under different money market conditions from U.S. conditions. FOMC also looked at Bank of England's Funding for Lending Plan. Such plan looks interesting, but open to bank gaming. This plan was rejected because minutes say “importance of institutional differences between the two countries was noted.”

FOMC comments appear to tell of a majority seeing progressing weakness, as opposed to a soft patch. QE3 looks like a matter of time, with reservation of hesitancy among some members. Where will any substantial and sustainable data of economic growth come from?