Does the Fed Really Need to Do Another QE?

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Whether you agree with it or not, reality is the Federal Reserve is likely to embark on another round of quantitative easing -- money printing -- in the coming months. And whether you agree with it or not, the logic behind such a move is that, by buying government bonds and mortgage securities, the Fed can drive down interest rates, enticing businesses and consumers to borrow, expand, refinance their mortgages, and whatnot.

But it's worth asking whether interest rates will actually fall if another round of QE goes into effect. There's good evidence that they won't. In fact, there's good evidence that they'll rise.

The Fed has already completed two rounds of quantitative easing, giving us clear examples of how interest rates have fared during periods when it's trying to push them lower. Neither is kind to the argument that QE helps lower borrowing costs. Quite the opposite:  


Interest rates have actually risen during both periods of QE.

There could be a couple of explanations for this. One is that all the money printing sparks fears of inflation, pushing interest rates up. But that's unlikely, since the overall trend of interest rates over the last four years has been down, down, down. Another is that QE actually did help boost the economy, and rising interest rates reflected optimistic investors willing to take more risk, abandoning the safety bunkers of Treasury bonds.

But there's another explanation that isn't as appreciated. In investing, you often hear the saw of "buy the rumor, sell the news." I think that's what we've seen with QE. Both rounds of Fed action, as well as the likely upcoming third bout, have been telegraphed loudly beforehand by the Fed to the point of being universally expected by investors well before they actually began. By the time actions were officially announced, investors looking to buy ahead of the Fed were already positioned. That's likely why interest rates have declined sharply in the months before QE official started. People bought the rumor and sold the news.

It's also likely why interest rates have plunged in recent months. A Reuters poll last week of primary dealers -- bankers who directly deal with the Fed -- put the odds of QE3 at 70%. Those expectations have almost certainly pushed interested rates down this year. Ten-year Treasury rates have plunged from 2.4% in March to 1.5% today.

If lower interest rates help boost the economy, there you have it. They're already here, driven by anticipation of QE3.

That sets up an interesting scenario. Does the Fed really need to do another round of QE if its benefits -- lower interest rates -- are already here? Four years ago, then-Treasury Secretary Hank Paulson said, "If you have a bazooka in your pocket and people know it, you probably won't have to use it." The quote, reflecting his hope that he wouldn't need to bail out the financial system, didn't work as planned, but there's real truth to the idea. If the Fed merely convinces the market that it's prepared to act, it can generate the kind of stimulus it hopes to accomplish without even acting. The language the Fed has used in recent press announcements -- promising to "provide additional accommodation as needed" -- is one of its most effective tools.

The article Does the Fed Really Need to Do Another QE? originally appeared on Fool.com.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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