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Doubts Over Fed Asset Purchase

Doubts are rising over the Fed’s ability to expand its asset purchase program even if U.S. inflation is falling and unemployment remains high. In early November, the Fed announced it intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The objective is to maximum employment and promote price stability. The Fed’s purchase, creates money and buying Treasuries should bring down long-term interest rates. But 10-year Treasury yields has risen since the announcement of the asset purchase. Concern that the Fed's actions has raised inflationary expectations and have prompted investors to demand a higher premium on inflation risk.
The success of the latest round of asset purchases will depend on managing expectations. The Fed will need to speak more about his strategy that the central bank will be willing and has the tools to withdraw the stimulus before inflationary pressures rise sharply. The Fed has recognized that its decision to launch QE2 would be heavily criticized, and the minutes from the November meeting due on Tuesday may help clarify the central bank’s reasoning. Not only is the FOMC clearly divided, but the Fed has struggled to manage expectations about the effectiveness of additional quantitative easing. With the minutes come the FOMC’s updated forecast, which likely will paint a darker picture of growth and inflation next year. The Fed will acknowledge that the downshift in the second half of 2010 was more severe than anticipated and will also lower its outlook for 2011 closer to 3%. This is barely above the economy’s potential.
Global Economic Insight and Analysis expects Treasury yields will move down again as the Fed continues to buy Treasuries and as the economic outlook gets downgraded.


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