Get Ready for QE4

Markets have been excessively spooked by the prospect of Federal Reserve “tapering” (reducing bond purchases). Rates on long-term treasuries have risen by 100 basis points since hints, first voiced by Chairman Bernanke at his May 22 Joint Economic Committee testimony, that if economic performance holds steady (growth above 2 percent and unemployment falling) or improves and inflation remains low (it is actually falling, to a 1 percent or lower pace), the Fed could start reducing the pace of its bond purchases by year-end. It is more likely, in view of the negative impact on the already weak U.S. economy arising from the higher interest rates resulting from taper talk, that the Fed will have to reverse itself and start talking about “un-tapering” or quantitative easing round four (QE4) at its December meeting, says John Makin, a resident scholar for the American Enterprise Institute in Real Clear Markets.

There are three reasons to expect reversal of the higher interest rates and the taper talk that have emerged since May.

First, the supply of treasuries coming to markets (government borrowing needs), by virtue of a sharp reduction in the heretofore $1 trillion budget deficit, drives down interest rates.

Second, another reason for the reversal in “taper trauma” interest rate increases is the slowing of the U.S. economy that is currently underway.

A third reason for interest rates to fall back toward April’s record low levels, and perhaps, for quantitative easing round to rise back-to-or-above April’s record high is tied to a persistent drop in inflation that has appeared since mid-2011.

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