Quantitative Easing, Round Two

Introduction

With just two days remaining until the Federal Reserve Board’s key policy meeting, it is almost impossible to avoid the term “quantitative easing round two (QE2)” in the financial press. Ever since the keynote speech by Fed Chairman Ben Bernanke last August , rumors have been rampant that the Fed will implement a daring strategy to ease unemployment and tamper deflation. But what exactly is QE2, and what can the Fed accomplish with this new tool? More relevant to corporate cash investors, what are the likely implications of this policy shift on yields and risks in the short-duration investment universe?
In this monthly installment of our research commentaries, we seek to summarize the general features of QE2, the issues and controversies which surround it, and what corporate treasurers should anticipate if and when the Fed embarks on this journey.

The Goals Behind QE1

As the nation’s central bankers, the Federal Reserve Board is tasked with regulating the supply of money in the financial system to achieve optimal levels of economic growth and employment. After exhausting the limits of its conventional form of monetary easing by lowering the Federal funds rate to a range between 0% and 0.25% in December 2008, the Fed next began a program through which it purchased U.S. government securities for its own account. In its official capacity, the Fed essentially exchanged freshly-minted paper currency for the securities it bought, thereby injecting fresh money into the financial system and lowering lending rates in hopes of encouraging lending, consumption, and capital investments – hence the term “quantitative easing”.
Since first announcing the $100 billion purchase of government sponsored enterprise (GSE) debt and $500 billion in GSE mortgage-backed securities (MBS) on November 28, 2008 , the Fed’s balance sheet has nearly tripled to $2.3 trillion as of October 10, 2010. Its securities portfolio ballooned from $790 billion to $2.0 trillion during the same period (See Figure 1 on page 2).
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