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Federal Reserve: To Act or Not to Act

The Federal Reserve has been clear in its intentions to stand ready to step-in and further stimulate the economy when, and if, needed.  The stimulation would be provided through further doses of quantitative easing as lowering interest rates further is a tool that has now pretty much been taken away from the Fed given the historic low level of interest rates today.

Such proclamations by the Federal Reserve have given the market great comfort in knowing that the fear of a potential double-dip recession has been reduced due to this level of support.  In our opinion at Hennion & Walsh, it was this very level of expressed support that accounted for the dramatic rise in the equity markets during the month of September as we cannot point to any other clear economic or market signals that would support such an increase.

Given the low current readings on inflation and the lack of significant GDP growth, a rational case can be made for additional stimulus measures.  The question as we see it, however, is should this stimulus come from the government and, if so, should it be through the form of quantitative easing?  According to Investopedia, quantitative easing is a government monetary policy occasionally used to increase the money supply by buying securities, such as U.S. Treasury Bonds, in the open market.  Often referred to as “printing money,” the first round of quantitative easing engaged in by the Federal Reserve did not deliver on its ultimate objective because of a lack of demand as opposed to a need for more of a supply of credit.

As a result, we are pessimistic about the ultimate potential for a second round of quantitative easing despite the need to inflate the economy.  Given the record low level of interest rates already, we would prefer to see private businesses take the lead in economic recovery efforts as opposed to being artificially propped up by the federal government as once the government assistance is removed, as we have seen with the home buyer tax credits in the housing market, the private business market is then left to stand on its own legs — perhaps before it is ready or able to do so.

We are not the only ones to share this pessimism.  In fact, the Federal Reserve has a fairly ardent dissenter in its own ranks as Thomas Hoening, president of the Federal Reserve Bank of Kansas expressed the following sentiment during a recent speech, “There is simply no evidence the additional liquidity would be particularly effective in spurring new investment, accelerating consumption, or cushioning or accelerating the deleveraging that is hopefully winding down.”