QE2 Eureka, It Worked!

It is official, the Federal Reserve’s Quantitative Easing 2 (QE2) has worked. For those of you who have their doubts, here it the Bloomberg article that makes this claim. Still not convinced? Well, neither am I.

Let’s us recap. Quantitative Easing is a fancy term for the Fed’s decision to buy $600 billion worth of US Government bonds from freshly minted money. Bernanke spent countless hours trying to explain to the world why this scheme is a good idea. His argument went essentially like this: We buy bonds, that drives up the price, by virtue of bond math, higher prices translate into lower interest rates (this is actually true), lower interest rates make mortgages and car loans cheaper, this causes people to go on spending sprees, and this consumer demand fixes the economy.

Interestingly, the article claims that QE2 worked, because the S&P 500 gained 17% since August 27, when the Fed started talking about QE2. Now, maybe I missed it, but I didn’t hear Bernanke say that he wanted to boost the stock market. He wanted to lower interest rates to spur consumer demand. Supporting the S&P 500 was not one of the objectives of QE2. It can’t be a measure of its success.

So how did the Fed do with interest rates? To pick one example, the national average rate for a 30 year fixed mortgage on 8/27 was 4.36%. Yesterday it was 5.07%. Even in Washington it is hard to argue that 5.07% is less than 4.36%.

It is perhaps even more telling to look at how the mortgage rate changed from November 12, when the Fed started buying bonds, to now. On November 12th, the 30-year rate was 4.43%, so the entire increase in interest rates occurred after the Fed announced the specifics of their plan.

Publicly celebrating the success of an interest rate reduction effort that ‘lowered’ rates from 4.4% to 5.1%  is uncomfortably reminiscent of Orwell’s1984 where the chocolate rations went ‘up’ to 25 grams [from 30 grams the year before].

P.S. In case you are wondering about the S&P 500 gain, it is a reflection of the economic recover. Virtually every indicator points to a slow, but steady recovery. And no, the Fed didn’t have anything to do with it unless you are willing to believe that the money the Fed has been printing has somehow cycled through the whole economy in 5 short weeks to cause job growth, new construction, credit expansion and all that. Normally the effects of such policies take at least six months to be felt, but perhaps the Fed’s magic is not limited to determining whether interest rates are up or down.

Posted by Martin Gremm (Pivot Point Advisors)

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Marc Schindler, CFP®

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