Tuesday, August 10, 2010

Fed Begins Incremental QE2

No one can say that this comes as a surprise.  The Fed hasn't crossed the Rubicon towards hyperinflation just yet, but it has definitely waded in:

The Federal Reserve on Tuesday took a small but significant step to counter a weakening U.S. economic recovery, saying it would use cash from maturing mortgage bonds it holds to buy more government debt.

Fixed-income portfolio managers recognize this as a yield enhancement technique.  When you're unsure of which way to bet on interest rates, just use the spare cash you have to buy more of what you already have.  The difference here is that the Fed is such a potentially large buyer of bonds that it creates its own demand.  The supposedly independent Fed is now a hostage to politics that demand an indefinite postponement of America's sorely needed wake-up call. 
All ordinary policy tools are exhausted, so the Fed is left with incremental steps back into asset purchases and the eventual creation of more artificial liquidity when the incrementalism proves insufficient.  Whatever exit strategy the Fed had contemplated up until now is gone.  The only possible exit from this mess will come when a run on the dollar forces full-on hyperinflationary QE.