Deutsche Bank and the Curious Case for QE Infinity



When the U.S. Federal Reserve announced its third round of post-crisis quantitative easing in September of 2012, it did something new. QE3 instituted an ongoing, open-ended flow-rate of asset purchases, as opposed to purchasing a set stock of assets over a set period of time, which was the way most previous rounds of QE were conducted.

QE is an unconventional monetary policy too that has four primary effects on the economy: higher inflation expectations, currency depreciation, higher equity valuations, and lower real interest rates. QE is similar to normal monetary policy (i.e. raising or lowering the target federal funds rate) in that it puts downward pressure on nominal and real interest rates.

All this is well and good, and with the fed funds rate trapped at the zero bound, that the Fed engaged in QE was unsurprising. QE1 began in December of 2008, and the strategy proceeded more or less normally until about June 2011 when the Fed realized that despite slamming its foot against the figurative gas pedal of the U.S. economic engine, the economy wasn’t really growing — not nearly as much as expected, at least.

The problem (one of many, perhaps) is that traditional QE begins, and ends. Effectively, the Fed says “this is how much stimulus we are going to provide, and this is the period over which we are going to provide it.” During the period of stimulus, financial markets (and ostensibly other businesses) react as if somebody slapped them in the thigh with an adrenaline booster shot.

When the stimulus ends, though, so do its effects, and the economy is not necessarily any better off than it was before. Monetary stimulus can really only provide a short-term boost. The open-ended flow-rate prescribed by QE3 tried to address this problem. Instead of saying “here’s how much and over what period,” the Fed said “this is how much each month, until further notice.”

To its credit, Fed policymakers did offer as much insight into their thinking as they could, and explained the thresholds within which a policy change may be made. They would continuing purchasing assets — $40 billion worth of mortgage-backed securities and $45 billion in longer-term securities each month — as long as inflation expectations did not exceed 2.5 percent. They would consider tapering the purchases when it looked like headline unemployment was going to drop below 6.5 percent.

QE3 has been, for lack of a better term, controversial. Economists and market participants were quick to label it “QE Infinity” because of its open-ended nature. Fed policymakers have said nothing about when tapering could begin except that it depends on incoming data — and incoming data paints an entirely opaque picture of the economy. The recovery has been moderate, but moderate is not good enough. The Fed doesn’t want to take its foot of the gas until it’s sure the economy is up to speed.

But some people aren’t sold on the idea that the economy will get up to speed within the next few years — if ever. The Fed may find itself trapped, and trip awkwardly into QE Infinity. ZeroHedge got a hold of note from Deutsche Bank, in which Jim Reid describes the musings of the firm’s U.S. rate strategist, Dominic Konstam.

“If you’re looking for a less consensus view, I was chatting with DB’s US rate strategist Dominic Konstam yesterday and he is continuing to run with his recent theme that the labour market is exhibiting “late cycle” tendencies, which lead him to believe that this cycle only has a 50/50 chance of extending much beyond 2015. Therefore, he is considering the prospect that the Fed possibly only has a narrow window to taper before it’s faced with economic headwinds again and if this is the case then why bother taper at all? If employment is indeed late cycle maybe the conditions don’t quite get strong enough in 2014 to persuade the Fed to be too aggressive in pulling back liquidity.”

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