Bernanke, setting the stage for a third round of quantitative easing in an Aug. 31 speech in Jackson Hole, Wyoming, said the strategy works in part by boosting the prices of assets such as equities. In a speech yesterday in Indianapolis he said higher stock and home prices would provide further impetus to spending by businesses and households.
“It’s pretty clear that the stock market is the most important transmission mechanism of monetary policy right now,” said Peter Hooper, chief economist at Deutsche Bank AG in New York. “That’s where you’re getting most of the action in terms of lift to the economy. It’s the stock market that’s going to have to be carrying the load.”
The Fed’s large-scale asset purchases will probably lift stocks by 3 percent over the two years following the Sept. 13 announcement of QE3 as low yields on government bonds push investors into risker assets, according to a Sept. 27 report by Deutsche Bank economists. They also estimate that QE will lift home prices by 2 percent over two years, assuming the Fed maintains purchases of Treasuries and mortgage debt through 2013.
The gains in stocks and real state could boost economic growth by 0.5 percentage point over the next two years, enough to add about 500,000 jobs and cut the unemployment rate by 0.3 percentage point, according to Hooper, who worked for 26 years as an economist at the Fed board in Washington.
Similarly, Goldman Sachs Group Inc. analysts led by Jan Hatzius estimated in a Sept. 19 report that eased financial conditions resulting from Fed stimulus -- including a weaker dollar, higher stock prices and lower interest rates -- would boost growth by as much as 0.5 percentage point over the next year.
The Federal Open Market Committee said it plans to buy $40 billion of mortgage debt a month. For the first time, the Fed didn’t set limits on the size or duration of the program, saying that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
The Fed also extended its forecast for “exceptionally low” interest rates through the middle of 2015, from an earlier date of late 2014. The central bank lowered its benchmark interest rate almost to zero in December 2008 and has since relied on quantitative easing to push down longer-term borrowing costs.
“They’re very explicit about trying to create financial conditions to try to support the economy,” said Ward McCarthy, chief financial economist at Jefferies & Co. in New York and a former Richmond Fed economist. “It’s become more explicit out of necessity, because the Fed doesn’t have the Fed funds rate to use as a tool because of the zero bound.”
U.S. stocks erased losses in the final hour of trading as Apple Inc. rebounded from a six-week low, helping the market recover from a drop triggered by concern about Spain’s finances. The Standard & Poor’s 500 Index (SPX) rose 0.1 percent to 1,445.75 at the close of trading in in New York after retreating as much as 0.4 percent.
Elsewhere, the Reserve Bank of Australia lowered its benchmark interest rate by a quarter percentage point to 3.25 percent to revive demand outside of a resource boom. In the U.K., a report from the Nationwide Building Society showed house prices fell in September.
The S&P 500 has more than doubled since reaching a 12-year low on March 9, 2009. Bank of America Corp. strategists project it will climb to 1,600 by the end of 2013, surpassing its record high of 1,565.15 reached in October 2007.
“It is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the FOMC’s decision to greatly expand securities purchases,” Bernanke said at Jackson Hole. “This effect is potentially important because stock values affect both consumption and investment decisions.”
Since Fed policy makers on Aug. 22 released the minutes of their July 31-Aug. 1 meeting suggesting another round of stimulus might be imminent, the S&P 500 has climbed 2.2 percent through yesterday. The index is up 15 percent this year, the biggest rally in a comparable period since 2009, data compiled by Bloomberg show.
Rising share prices are helping to boost the confidence of American consumers, whose spending accounts for 70 percent of the economy.
The Bloomberg Consumer Comfort Index rose to minus 39.6 in the week ended Sept. 23, the highest level since July, from minus 40.8 in the previous period. The Thomson Reuters/University of Michigan sentiment index rose to 78.3 in September, a four-month high, from 74.3 in August.
Signs of a turnaround in the real estate market are contributing to consumer optimism. Home prices in the second quarter rose by 2.2 percent from the previous three months, the best performance since the fourth quarter of 2005, according to S&P/Case-Shiller data.
Mortgage rates pushed down by Fed asset purchases are helping. Fixed rates offered for new 30-year loans fell to 3.40 percent yesterday from 3.57 percent on Sept. 12, the day before the last FOMC meeting, according to Bankrate.com data.
“This is a Main Street policy,” Bernanke said at a Sept. 13 press conference after the Fed announced QE3. “Many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend.”
Investors are proving skeptical that QE3 will get Americans to spend more.
The Consumer Discretionary Select Sector SPDR Fund -- which includes Amazon.com Inc. (AMZN) and Macy’s Inc. (M) -- has lagged behind the Consumer Staples Select Sector SPDR Fund by 2.8 percent since Sept. 14. During the preceding six weeks, the discretionary exchange-traded fund outpaced its defensive counterpart, which includes Procter & Gamble Co. (PG) and Coca-Cola Co. (KO), by 9.2 percent.
Investors usually overweight discretionary stocks when they’re optimistic about consumer spending, so the recent underperformance of these equities signals doubt about the long- term effect of QE3, said Jim Stellakis, founder and director of research at New York-based research company Technical Alpha Inc.
The strategy also carries risks, said Brian Jacobsen, who helps oversee $207.4 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin.
“The Fed gets caught perpetually trying to prop prices up higher and higher,” Jacobsen said. “What happens if the Fed takes away the training wheels?”
The bond purchases have generated opposition within the Fed as well. Increasing stimulus “runs the risk of raising inflation” without doing much to improve the outlook, Richmond Fed President Jeffrey Lacker, who has dissented from every Fed decision this year, said in a speech on Sept. 18 in New York.
Philadelphia Fed President Charles Plosser, who doesn’t vote on policy this year, told the Fox Business Network on Sept. 25 that he’s concerned the search for yield by investors will lead to an asset bubble.
Under Bernanke’s predecessor, Alan Greenspan, some investors theorized that the Fed would reduce interest rates to prevent equity-market declines, a concept that became known as the “Greenspan put,” after the options contracts that protect against stock-market declines.
“The ‘Bernanke put’ is more clearly communicated,” said Stephen Wood, the New York-based chief market strategist for North America for Russell Investments, which oversees $152 billion. “The press conferences give more detail about what the Fed is thinking and why.”
The Fed’s targeting of specific asset classes is unprecedented, according to Allan Meltzer, a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh.
“It’s not going to do any good for the economy,” said Meltzer, the author of a two-volume history of the Fed. “It’s going to make money for the speculators.”
The world’s largest economy expanded at a 1.3 percent annual pace in the second quarter after growing at a 2 percent rate from January through March, Commerce Department figures showed Sept. 27. Fed officials see growth this year at 1.7 percent to 2 percent, according to forecasts released last month.
“We expect the economy to continue to grow,” Bernanke said to the Economic Club of Indiana yesterday. “Our concern is not really a recession. Our concern is that growth will continue but at a pace that’s insufficient to put people back to work.”
Policy makers will probably stick with the bond-buying strategy through next year, said Deutsche Bank’s Hooper, who predicts the central bank will end up buying a total of $800 billion of Treasuries and mortgage-backed securities.
“The Fed sees asset prices as a medium objective -- its ultimate objective is, of course, stable inflation and the highest sustainable employment,” said Dana Saporta, U.S. economist at Credit Suisse Group AG in New York. “I give the Fed the benefit of the doubt that, without these unconventional balance-sheet policies, the economy would be in much worse shape today.”
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