Quantitative Easing 2 (QE 2) Update and Analysis

On November 3, 2010 the US Fed (Federal Reserve) announced the policy of Quantitative Easing (QE) 2. The stated goal of the policy was to decrease interest rates in order to jump start the economy and reduce the US’s persistent unemployment rate of just under 10%. The major side effects of QE 2 are that it would devalue the US currency and make commodities more expensive since they are valued in US dollars. At the same it would make US manufactured goods cheaper for companies and customers outside the US which should lead to an increase in US exports, at the same time making imports more expensive thus decreasing imports.

After six weeks (as of December 18, 2010), what has been the effect of QE 2?

US Treasury interest rates - The interest rate yield has increased on the 10, 20 and 30 year treasury bonds. The 10 year has increased 33%, the 20 year has increased 16% and the 30 year has increased 9%. Mortgage rates track the yields on the 10-year Treasury note. For example, if you add 150 (1.5%) Basis Points (BPS) to 160 BPS you will get the 30 year fix mortgage rate. The current national 30 year fixed rate is 4.83%; on November 5, 2010 it was 4.24% (an increase of almost 60 BPS). With the increased cost of borrowing for companies and consumers, it will reduce their spending on goods and resources. This will have the effect of decreasing economic growth.

US unemployment rate - The November 2010 (December rate will be announced January 7, 2011) unemployment rate was 9.8%. I will need to review the unemployment rate over the next 6 months.

Commodities prices - Almost all commodities prices have continued to increase after the announcement of QE 2. For example, the US national gasoline price has increased over $.17, oil (Brent) has increased $5 a barrel, copper increased 9% and wheat has increased 9%. This increase in commodity prices will increase the price of goods, food for example, and decrease companies’ and consumers’ ability to spend more on goods and services. It could also lead to inflation.

US real GDP (Gross Domestic Product) - The real GDP rate for the third quarter was 2.5%. I will continue to check back on the real GDP rate over the next 6 months.

US imports / exports – The August 2010 US 12 month trade balance was negative $621.4 billion. I will review the 12 month trade balance periodically over the next 6 months.

US dollar - The US dollar has decreased by 5% compared to the Euro and 4% compared to the Japanese Yen. This should increase US exports (they will be cheaper) and decrease imports (they will be more expensive).

Currently the primary issue with QE 2 is that interest rates are increasing, which leads to increased cost of financing which could in turn slow the growth of the economy, counter to the intent of QE 2. This should, however, be neutralized by the large tax decrease and stimulus approved by Congress and President Obama on December 17, 2010.

© 2010 Paul Cusick

Paul