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'Quantitative Easing': What Does It Really Mean for Investors?

Monday, 23 Aug 2010 | 2:27 PM ET

'Quantitative easing' refers to various steps the Federal Reserve can take in order to increase money in the economy.

Investors will be focused on this week's Fed summit at Jackson Hole to determine what the central bank will do.

Investors queasy over whether there's anything that can be done to boost the flagging US economy could get a trillion-dollar answer this week from the Federal Reserve.

When officials from the central bank emerge from this week's Jackson Hole, Wyo., retreat, they will likely disclose the latest in the arsenal of so-called "quantitative easing" measures.

The term has become a regular part of investor vernacular since the beginning of the financial crisis. Primarily, it describes the various measures the Fed has taken and will take to keep money flowing in a recessionary economy—"printing money," as some say.

How the latest steps get implemented likely will be a cornerstone of the address Fed Chairman Ben Bernanke will deliver Friday.

"Traders are going to be paying attention to whether or not he talks about quantitative easing and whether he downgrades the economic projections even more," says Quincy Krosby, strategist at Prudential Financial in Newark, N.J.

"If he does, it's almost a foregone conclusion that he's setting the stage for major quantitative easing," Krosby adds. "There is growing acceptance that if the data continue to deteriorate, the Fed will embark upon major quantitative easing to the tune of perhaps a trillion dollars."

So what does that mean to investors?

Quantitative easing—or "QE" as it has become known—looks to increase money in the economy. For the Fed, the most prevalent tool is the cutting of its funds rate, which in turn pushes other rates lower.

But the Fed can no longer cut rates, as the funds rate is near zero. So it will have to use other measures. The most likely under consideration being the purchase of Treasurys and perhaps other debt-backed instruments, such as auto loans and credit card securities—in the interest of driving down rates and making capital more accessible for consumers and businesses.

How dramatic the changes will be is unclear, but most observers expect Bernanke to be aggressive in guarding against deflation. That will be an important point for investors to remember when the chairman starts talking about QE.

"Part of it's psychological—the Fed's acting like a backstop. They're saying, 'We've got your back,'" says Doug Roberts, chief investment strategist at Channel Capital Research in Shrewbury, N.J. "What you want to do is make sure the Fed's not behind the curve."

But the Fed has done little to assuage market fears lately.

After the last Fed meeting, the market nosedived when it interpreted the Open Market Committee's statement to mean that the central bank was standing pat and would not be providing stimulative measures.

Since then, a variety of regional Fed presidentshave delivered marks that have been increasing hawkish on deficits and inflation, providing further uncertainty.

Wall Street, then, likely will want some firm direction from Bernanke about what role the central bank will play going forward.

"Bernanke could cut through much of this confusion—and clarify the views held by the majority on the FOMC—at Jackson Hole," Bank of America Merrill Lynch said in a research note. "Still, that is a long time for the market to hold its ears while the hawks keep squawking."

Should Bernanke provide reassurance, that could pull the market out of the rangebound trading it has seen for much of the summer. The market was at almost the exact level Monday as it was on June 24.

"The goal will be for the Fed to push down yields and help companies and help consumers," Quincy Krosby says. "The issue is how much pushback there will be. Which side will the market take?"

Investors could take another round of Fed Treasury purchases as the cue to keep the improbable bonds rally going.

They could also react to more QE by simply buying stocks, on the notion that more liquidity in the system will be a good reason to boost equity levels at least on a nominal basis. The heightened money supply is often cited as a reason for the massive rally off the March 2009 stock market lows.

But Wall Street likely will need more coaxing by Washington before jumping full-bore back into the stock market.

"Given the concern of what's going on in the economy and the potential for a double-dip, I'm looking for more substance to come out of the executive and legislative branches of government and not necessarily out of the Fed," says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles.

The primary question from this week's conference, then, seems to be a matter of degree.

"I don't think they're going to make a lot of changes. They're going to continue to say they support the economy and continue to use quantitative easing," says Vern Sumnicht, CEO at iSectors, an ETF-focused investment company based in Appleton, Wisc. "Quantitative easing for the Fed means printing money."

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