Continued Fed Easing

The Federal Reserve last week announced another round of quantitative easing, where it will make monthly purchases of $45 billion in intermediate to long-term Treasury securities. This is in addition to the monthly purchases of $40 billion in government- guaranteed mortgage-backed securities. While these actions were widely anticipated, certain details in the statement, such as targeting specific unemployment and inflation targets, were not. The Fed will now continue its easy money policies until the unemployment rate reaches 6.5%, or until inflation expectations over the next 1-2 years go above 2.5%. As bondholders, we are particularly focused on the inflation component to the statement. 2.5% is 50 basis points higher than what was thought to be the Fed’s 2% inflation comfort level. With these specific targets now in place, it is clear that the Fed is favoring policies to increase employment, with the cost being higher inflation. This follows actions by other central banks, such as the Bank of England, which suggested recently that nominal GDP targeting may be justified. The question now becomes a concern as to whether the Fed will ever be able to end these easy money policies, and if higher inflation is the inevitable result. We’ll be watching closely for the answer, and will adjust our portfolios to protect clients from these inflationary threats.