Risky assets faced another sell-off recently after the Fed remained silent on any new quantitative easing program during their latest FOMC meeting, June 19-20, 2012, although they conceded that they were prepared to take further action to safeguard the US economy if the Eurozone crisis takes a turn for the worse.
At that meeting, the FOMC resolved – albeit not unanimously – to maintain the Fed Funds rate at 0.0-0.25 percent and pledged to keep rates at ultra-low levels until at least late 2014. In addition, they decided to extend Operation Twist, which is due to end this month, through to the end of 2012, using another USD267 billion, versus the USD400 billion in the current round, where they swap short-term Treasuries with the maturities of three years or less for bonds with maturities of 6-30 years (and thus should not affect the Fed's balance sheet). That move is designed to lower long-term interest rates and further ease the financial environment.
In light of current US economic conditions amid a prolonged Eurozone crisis, KResearch believes that financial and capital markets are pinning their hopes on another Fed quantitative easing program (QE3) to reduce risk in an underperforming US economy. However, the effectiveness of this financial instrument might be limited despite the new money the Fed plans to inject directly into the economy, as increased money supply could steepen inflationary pressure later on, leaving the Fed in a difficult position to absorb excess liquidity then.
Aside from the Fed, KResearch expects that ECB and other major central banks are now finding themselves in awkward positions where they have to find new financial tools, too, despite an easing environment that has helped ameliorate recessionary risk or any ‘hard landing'. With few policy tools left to choose from, the central banks may not be able to shore up economic activities or resolve the crisis any time soon. Eventually, the governments (not only the US) may need to relax fiscal controls, or become more flexible in their fiscal policies as a last resort toward fending off a global economic cataclysm.