But the new Fed policy tools work through some very specific mechanisms, many of which can be measured by what is happening in financial markets. In that sense, we can get some early returns on how QE3 is affecting the economy, for good or ill. I’ll give each one a letter grade, depending on how well that measure is fulfilling the Fed’s goals so far.
Mortgage rates: C+
One of the key benefits from the easing policy is to push down interest rates for mortgages and other long-term loans, such as certain corporate investments. The policy includes buying $40 billion of mortgage-backed securities, issued by the likes of Fannie Mae and Freddie Mac, each month. That means the Fed is funneling newly created money directly toward home loans to try to make it cheaper for Americans to buy or refinance a house.
There seems to be a hitch in the system, though. The week before the Fed’s policy meeting July 31 and Aug. 1, when the committee first hinted directly that QE3 was coming, 30-year fixed-rate mortgages averaged 3.49 percent, according to Freddie Mac. The first full week after the announcement — the week that ended Sept. 20 — the number was exactly the same. Rates dipped a bit more, down from 3.55 percent, from the week before QE3 (ended Sept. 6) to the week after, but this was a situation in which markets gradually priced in the policy over a period of months.
What seems to be happening is that banks are cutting the mortgage rates they charge customers only gradually; if the banks slashed rates too fast, they would be overwhelmed by the demand from Americans looking to refinance or buy a home and would not be able to handle the load. Keeping rates high increases banks’ profits and allows them to winnow demand to a manageable number of applicants.
That may be bad news for potential home buyers and refinancers right now. But it comes with a silver lining: It implies that rates should come down over the months ahead as banks work through their backlogs.
Inflation expectations: A-
Investors are expecting inflation to rise. And that may be a good thing.
Bond market indicators are pointing to significantly higher inflation in the coming years than they did this summer, which seems to be a direct reflection of QE3. The difference between rates on ordinary five-year bonds and those indexed to inflation, a measure of how high investors expect inflation to increase, was 2.17 percent Monday morning, down from a recent high of 2.37 percent just after the policy move but well above its level of 1.68 percent before that July-August policy meeting.