The chairman today announced that they would initiate a bond buying program that continues indefinitely. The Federal Reserve will be buying bonds at a rate of about $85 billion per month, a increase of $40 billion over the previous rate. That equates to buying all of AT&T's (NYSE:T) debt (and then some), or all of American Express' (NYSE:AXP) debt (and then some), or all of Wal-Mart's (NYSE:WMT) debt (and then some), or nearly all of Ford's (NYSE:F) debt each month.
The effect the Federal Reserve hopes to achieve is, in economic terms, the reduction of the long term interest rate. This is basically the same goal as "Operation Twist." However, in Operation Twist, the Fed was trying to lower the long-term rate at the expense of the short term rates. The move left more short-term securities in public hands and loaded the Federal Reserve balance sheet with longer term securities. Effectively, Bernanke was just swapping his short-term treasuries for long-term treasuries.
During Operation Twist, the Fed achieved its goal of lowering long-term interest rates to some extent:
The announcement today, however, is strictly a new bond buying program -- again, with the desired result of lowering long-term interest rates. Given the clamoring of the news stations for more QE, the Federal Reserve basically had little choice but to reiterate their program.
In reporting the announcement, the New York Times writes:
The new purchases will be the first time in more than two years that the Fed has expanded its holdings of mortgage bonds. That decision reflects the Fed's view that the housing market still needs help, and that lower rates on mortgage loans could provide significant benefits for the broader economy.
Apparently, despite their improvement, new housing starts are not good enough:
The WSJ writes:
...the Fed's policy-making committee said it would buy $40 billion each month of agency mortgage-backed securities on an open-ended basis and said it could extend those purchases and buy additional assets if the job market doesn't improve.
Watch for homebuilders to be on the rise.
One last and important detail: the Fed pledged to keep interest rates as low as they are today through mid-2015 (yes, for the next three years).
The Signal -- Not The Noise
All in all, QE only matters for investor confidence. It is hard to imagine that the Fed can do much good pushing the prices of debt higher (that is, the price of loaning higher, while the price of borrowing falls). And given that treasuries already yield negative real returns, we ought not to put much stock in this announcement.
Will people speculate on the way other people will react to the chairman's comments? Yes, of course. Will this extra QE make a bit of difference to the long-term investor? Probably not, although in theory (that is, in Austrian Business Cycle Theory) they are distorting long-term capital allocation and preserving bad projects which should be liquidated and reallocated.
Needless to say, with the announcement, we may continue using ultra low discount rates when valuing businesses since the "risk-free" rate component promises to remains ridiculously low. And the lower the discount rate, of course, the higher the share price. The effects of QE probably still bode well for share prices, just not for the U.S. economy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.