The fact that the Federal Reserve has decided to keep interest rates close to zero is a sign they are indeed afraid for the state of the US economy. And they have a good reason to be. Unemployment has increased, consumer spending has declined, industrial production has declined, and credit conditions are still tight. There is much more that could be added to this list, but with interest rates close to zero, the Fed can no longer continue to lower the interest rates. So how will they fight the recession from now on? A new media phrase, quantitative easing, looks like their next step. But what exactly is it?
To put it in simple terms, “quantitative easing” means increasing the supply of money or injecting liquidity to the markets by printing money, which they will use to purchase securities. The Fed has engaged in printing more money than normal from time to time, but it’s likely they will do so more aggressively right now in hopes of bringing about an upturn in the economy.
Currently, we are in a time of great financial market stress. The Federal Reserve has a huge job ahead of itself to rebuild investor confidence to keep the economy out of deflation. There is no doubt that the Fed has been aggressive in doing what it can to prevent the US economy from diving into an economic collapse. They have been buying commercial paper and providing credit lines to investment banks and dealers just to keep things afloat. But their response may not have been adequate. Quantitative easing was used by the Japanese central bank from 2001 on to fix its deflationary crisis, but it was not as effective as it was thought it would be. If it didn’t work for the Japanese, does that mean the Fed will have to come up with other ways of stimulating the economy?
In a constantly changing landscape, instead of trying to find the best solution, it could be that something satisfactory may suffice. So how long will it be before we see a turnaround in the US economy? And will we have to wait that long before the markets turn around? Probably not. I think the markets will turn around well ahead of the economic recovery.
So all we can do is continue keeping an eye on the market and looking for trading opportunities. And if you are addicted to the markets, this should, of course, be second nature.