Tuesday, January 11, 2011

Why The Continuing Bewilderment About QE2 and Interest Rates?

Why do we continue to get the following line of reasoning about QE2 and interest rates reported in the press?
The trouble [with QE2] is, though yields fell sharply between August and November as the markets anticipated the new program, they have risen since it was formally announced in November, leaving many in the markets puzzled about the value of the Fed’s bond-buying program. 
This particular quote comes from the New York Times, but it is ubiquitous in the press.  As I and others have said before, a truly successful QE2--one that helps revive the economy--should ultimately lead to higher bond interest rates.  Yes, yields may initially fall but an economic recovery should be accompanied by rise in interest rates as the demand for credit increases.  Amazingly, after spending several paragraphs raising doubts about whether QE2 is working because of rising yields, the NY Times article closes with this from Brian P. Sack, the head of the NY Fed trading desk:
“Rates have risen for the reasons we were hoping for: investors are more optimistic about the recovery,” said Mr. Sack. “It is a good sign.”
And they save that for the closer?  How much more insightful the article could have been had there been some discussion about this point up front.  QE2 is far from perfect, but it is probably in some way contributing to the change in economic expectations and thus the uptick in interest rates. It is that simple.

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