Mr. Market so far is not at all impressed with the announcement today that the Fed will be changing the composition of its portfolio by selling $400 billion of near-dated Treasuries and buying the same amount of longer maturity Treasuries. Since the Fed will maintain the same Fed funds target rate, the Fed’s intent is to keep short term rates low and also reduce longer term rates.
The fallacy with the Fed approach, as our Marshall Auerback has pointed out repeatedly, is that targeting a quantity means the central bank has no idea what result it will achieve. An analysis by Jim Hamilton showed that $400 billion of QE in the past would have moved rates by all of 17 basis points, which is bupkis (and that’s assuming you think lowering of longer term rates further is a worthy goal when long term rates are already at historic low levels). From his 2010 paper:
We can summarize the implications of that forecast in terms of the following scenario. Suppose that the Federal Reserve were to sell off all its Treasury securities of less than one-year maturity, and use the proceeds to buy up all the longer term Treasury debt it could. For example, in December of 2006, this would have required selling off about $400 B in bills and notes or bonds with less than one year remaining, with which the Fed could have effectively retired all Treasury debt beyond 10 years. The figure below summarizes the implied average change in forecast for the 1990-2007 period as a result of this change for interest rates of various maturities. Yields on maturities longer than 2-1/2 years would fall, with those at the long end decreasing by up to 17 basis points. Yields on the shortest maturities would increase by almost as much. While our estimates imply that the Fed could make a modest change in the slope of the yield curve, it would not make any difference for the average level of interest rates. As we said, results may (as in will) vary, but the broader point is the last experiment of this sort produced underwhelming results.
And of course, to the extent the Fed is successful in flatting the yield curve, even modestly, this reduces the profitability of the basic operation of banking, which is maturity transformation (borrowing short and lending long).
Andrew Horowitz of The Disciplined Investor provided this side by side comparison of the FOMC’s last two statements (see here for his original):