With the expansion of purchases of mortgage-backed securities and the announcement that it will buy up longer-term Treasury securities to the tune of USD 300bn, the US central bank has boosted the scale of its unconventional measures substantially. Above all, this should make a significant contribution towards stabilizing the residential housing market since the mix of measures suggests that the Fed’s aim is to further reduce mortgage interest rates. Since October of last year rates on conventional 30-year mortgage loans have already fallen by 150 basis points to around 5%. Established yardsticks for the affordability of houses have thus risen significantly.
USA: Fed steps yet harder on the gas
At first glance the Fed’s moves should massively undermine the US-dollar. But if, as we assume, these measures serve to get the US economy up and running again, this will shore up the dollar in the coming months. To this extent, we see no reason to alter our exchange rate forecast of 1.35 USD/EUR at end-2009. The yield on 10yr Treasuries will be pushed down only temporarily. In the course of the economic pickup and the flood of government bonds we expect it to climb back up to a level of around 3 ¼% at the end of the year, a trend which will continue in 2010. The Fed’s measure is unlikely to exert any long-term downside pressure on yields as bond prices are also cost-of-carry prices which can change swiftly regardless of flows. The renewed focus on the topic of inflation will also serve to push up yields.
Such aggressive monetary policy is of course not without longer-term inflationary risks. The Fed’s measures bolster us in our view that we are not heading for a Japan scenario but that inflation is set to rise again. How steep this rise in infation will be depends on how resolutely the central banks rein in the expansionary impulse once the situation returns to normal. We expect this to occur since accelerating inflation (followed by a massive hike in interest rates) would be in nobody’s interest. It should not be overlooked that plans are already on the table allowing the Fed flexible management of its balance sheet in the future. Corresponding pointers can be found for instance in the joint statement by the Treasury, the Fed and the FDIC on the Financial Stability Plan on February 10, 2009. The expanded toolbox could, for example, allow the central bank to issue its own debt instruments. Such changes could put the Fed in a position to start jacking up interest rates despite its massively bloated balance sheet. All told, in light of the very difficult economic situation at present, the Fed’s decisions are warranted. Together with the numerous other economic policy measures already launched they should prompt an economic rebound in the second half of the year, providing an important fillip to the recovery of the world economy.
Dr. Michael Heise
e-mail: [email protected]