Fed’s QE3 Policy To Be Questioned On Capitol Hill

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U.S. equities pulled back on Tuesday after reaching record highs on Monday as investors digested a mixed bag of corporate earnings results and took some money off the table in advance of Federal Reserve Chairman Ben Bernanke’s testimony before the House of Representatives Financial Services Committee concerning the Fed’s semi-annual monetary policy report which is expected to provide the market with more signals about the Fed’s closely watched $85 billion monthly asset purchases with its third round of quantitative easing, known as QE III.

On Thursday Chairman Bernanke will respond to questions from lawmakers in the Senate. During his last Senate question and answer session in May, Chairman Bernanke admitted that the rate of bond purchases could slow in the next few Fed meetings which led to a market pullback and a spike with the yield on the 10 year Treasury amid growing speculation that the pace of the Fed’s bond buying could be tapered as early as September.

The yield on the 10 year Treasury climbed further in June, reaching a 22 month high and then surged higher to 2.71 on July 1st, eclipsing a near record low of 1.6 percent in early May.

Since the Federal Reserve launched their quantitative easing program in 2008 under Fed Chairman Bernanke’s helm, U.S. equities have returned to record highs, interest rates have fallen to near historic lows, helping the housing market to recover, and the unemployment rate has fallen to 7.6 in June 203 from its peak at 10.1 percent in October 2008.

Although the U.S. economy has clearly recovered since 2008, the Fed’s quantitative easing program has also sparked some controversy.

Since 2008 the Federal Reserve has expanded their balance sheet to over 3.4 trillion, leading many economists to conclude that the unwinding of the Fed’s large quantitative easing program will prove to be a challenging undertaking for the next Fed Chairman.

During the last Fed meeting in June, around half of the 19 Fed members said that they expected the Fed to end their bond purchases before the end of the year, according to the Fed minutes.

But only 12 Fed officials get to vote on monetary policy at each Fed meeting.

Many of those voting Fed members in the June meeting expressed the view that they still need to see further improvement in the job market before they would be willing to begin winding down the Fed’s quantitative easing program.

However, that dovish Fed sentiment was expressed prior to the release of the better than expected June employment report which was reported in early July, showing 195,000 jobs added to the economy in June along with a revision in total nonfarm payroll employment for April from 149,000 to 199,00 with May’s nonfarm payroll number also being revised higher from 175,000 to 195,000.

Combined employment revisions for April and May were 70,000 higher. The labor participation rate also moved higher  to 63.5 percent from 63.4 for the second straight month of gains.

Following the last June Fed meeting, Chairman Bernanke said the Fed could begin to “moderate” or taper its bond purchases later this year if its forecasts for inflation moves to their 2 percent longer term goal and the unemployment rate falls to around 7 percent as Fed policymakers forecast.

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains, a substantial improvement from the 8.1% unemployment rate that prevailed when the committee announced this program” Bernanke said.

The Fed made it clear that the federal funds rate will be decoupled from their quantitative easing asset purchases and will remain steady until the unemployment level lowers to 6.5 percent and inflation remains close to its 2 percent goal while long term inflation remains “well anchored.”

Rising Inflation

Latest inflation data released on Tuesday showed that inflation rose more than expected in June.

The Consumer Price Index (CPI), the most cited inflation indicator, showed that for the month of June consumer prices increased 0.5 percent, surpassing the estimate of 0.3 percent, according to briefing.com.

Excluding food and energy, core consumer prices grew 0.2 percent, in line with estimates.

Year-over-year, consumer prices climbed 1.8 percent, or 1.6 percent excluding food and energy.

Last week the U.S. Labor Department reported that its producer price index (PPI) which measures wholesale prices rose .08 percent in June, beating estimates of .02 percent, according to briefing.com and rising above a .05 percent increase in May.











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