If Fed Decides to Ease Again, Price Could Hit $1 Trillion

If the Fed decides that the US economy needs another round of monetary easing, the price tag likely would be between $700 billion and $1 trillion, according to a new analysis.

United States Federal Reserve
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United States Federal Reserve

While the Fed has not said explicitly whether it will enact a third round of quantitative easing — or QE3 in market parlance — speculation has grown that the central bank will step in should the economy stall again in 2012. The Fed next meets Tuesday, when the topic of more easing is likely to come up.

Recent indicators such as in housing, unemploymentand consumer confidencehave shown improvements, though most economists are expecting the gains to be temporary and, more importantly, susceptible to shocks from a European recession.

In that event, according to the analysis from Citigroup analyst Inger M. Daniels, the Fed likely would buy $700 billion worth of mortgage-backed securities, and possibly another $300 billion in Treasurys.

The primary aim would be to drive down mortgage rates even further from current levels that are hovering around record lows. Housing and unemployment remain the twin impediments to a full economic recovery in the U.S.

"We believe this level of purchases would align with the Fed’s stated goals of aiding borrowers while not allowing for egregious Fed concentrated ownership of the mortgage market," Daniels said in a research note.

That $700 billion total is predicated on a goal of cutting borrowing rates by a quarter-point.

The 30-year mortgage rate for the week ended Thursday was at 3.99 percent, according to Freddie Mac.

Emulating the first round of QE, which also targeted MBS, would entail $425 billion in fresh purchases and cut borrowing rates by just 0.15 percentage points, Daniels said. QE2 focused solely on Treasurys in an attempt to entice investors into buying riskier assets like stocks.

A Fed operation begun in September called Operation Twistdid not expand the central bank's $2.8 trillion balance sheet but instead entailed selling $400 billion worth of shorter-dated debt and buying an equal amount of debt with longer maturities, also in an attempt to drive down long-term borrowing rates.

"Much of recent Fed speak concerning QE3 has indicated a bias toward enacting measures that would directly impact the housing market," Daniels wrote. "This suggests QE3 purchases would be more heavily concentrated in MBS than in Treasuries."

While other also agree that QE 3 would entail some intervention in the housing market, the timing remains very much in question.

In addition to considerations of whether the program would be effective, the Fed's easing practices have sparked inflation concerns and protests from congressional Republicans and the GOP presidential field.

Daniels' analysis assigns neither a probability nor a time frame for more Fed action — she declined to offer an estimate in a subsequent email exchange — though informal consensus indicates that the action might not happen until later in 2012.

"We think additional easing in the form of QE3 is possible by the second half of next year, when we expect the economy to have weakened materially from fiscal policy-induced uncertainty," Michael S. Hanson, US economist at Bank of America Merrill Lynch, said in a recent note.

The improvement in U.S. economic data, as well as European policymakers' ability to forestall a massive negative fallout from the sovereign debt crisis, appear to have bought the Fed additional time.

"The Fed needs to be ready to act if the euro-zone implodes, triggering sovereign debt defaults and large-scale European bank failures," Paul Ashworth, senior US economist at Capital Economics in Toronto, told clients. "As it stands now, however, there is no pressing need to act immediately, particularly not when the incoming data suggest that the US economy is actually getting stronger. As such, we still think that the Fed will hold off on more quantitative easing until the first half of next year."