OBAMA’S JOB PLAN BRINGS CALLS FOR QE3

 
David Morris
AT THE end of last week, investors were digesting President Obama’s proposed $447bn jobs package. This was significantly bigger than the $300bn expected, and the hope is that it will encourage firms to start hiring again. But everything comes with a cost, and savings will have to be made elsewhere. The President has passed these decisions over to the Joint Select Committee on Deficit Reduction. The committee meets again today, and in addition to the $1.2-1.5 trillion savings it has to find over the next decade, it must now decide where the $447bn of spending cuts is going to come from.

The majority of market participants are unimpressed, saying that the plan simply repeats measures that have been taken before which have done nothing to help the economy. As equity markets slump, many investors are pounding the table for another round of Federal Reserve stimulus (QE3). The FOMC meets on the 20 and 21 September and the central bank’s options seem to break down as follows:

Additional asset purchases – this is difficult to justify and will lead to an outcry both internationally and domestically. More stimulus will undermine the dollar and spur inflation, which is particularly hard on emerging economies. In the US, Wall Street is seen as the only beneficiary of quantitative easing so far.

Operation Twist – the Fed sells its shorter duration debt and buys longer-dated Treasuries. The aim is to reduce borrowing costs for companies and individuals. But yields are already at record lows, and it is difficult to see how any fall from here will encourage further borrowing. Also, flattening the yield curve (as this would do) will hurt bank profitability.

Cut the rate paid on bank reserves. This is supposed to stimulate bank lending. But the rate is already low at 0.25 per cent and banks have plenty of lending capacity. The problem is that those who need to borrow aren’t credit-worthy, while the ones that are don’t want additional debt.

So the FOMC has no easy choices. In the meantime the European debt crisis has taken a turn for the worse. If Greece does default, then the decision to initiate a QE3 may get a whole lot more compelling.