Libya/Fed’s QE2: Strife in the Middle East could give the US Federal Reserve a hand with a big policy headache. James Bullard, president of the St Louis Fed, says an improving US economy renders the central bank’s bond-buying program less definitively useful. But reversing the policy known as quantitative easing is tricky. As long as Libyan unrest doesn't evolve into a full-blown oil crisis, a dose of safe-haven buying might give Ben Bernanke's Fed some cover.
The $600 billion second round of bond buying, known as QE2, is due to run until June. One concern is that the program is big enough for the Fed to be mopping up on average some 60 per cent of the Treasury bonds Uncle Sam needs to issue to fund this year's 13-digit deficit. Even if the QE2 end date is known - and all the more so should the Fed decide to cut it short - pulling that kind of buying power out of the market could rattle investors at large.
At first, it may not seem obvious how trouble in the Middle East could somehow help the Fed. The development of a prolonged oil shock wouldn’t: rather, that would squelch growth in the United States and everywhere else. And, despite also fueling inflation, it would incline the Fed firmly back toward loose monetary policy rather than a switch into tightening mode.
But assuming the tumult ultimately falls short of such a globally painful outcome, the intervening uncertainty could provide the central bank with an opportunity. A big slug of the fairly sharp rise in Treasury yields since January has been rolled back in just 10 days or so since violent unrest in Libya hit the headlines. That's a result of investors piling into US government bonds, traditionally one of the safest refuges around.
And that's Bernanke's opening. It is likely to be less disruptive to phase out the Fed's heavy buying of Treasuries if other investors are hankering for them. Of course, the moment could easily pass, even before the central bank's next interest rate-setting meeting on March 15. It's still something for the Fed boss and his colleagues to keep in mind.