Why Is The Federal Reserve Continuing Its ‘Soft’ QE Program If The Economy Is So Strong?

It wasn’t a big surprise for the financial markets to see the Federal Reserve hike the interest rate by 0.25% last week, and the stock market moved swiftly higher on the back of this announcement which has removed some uncertainty.

Source: propertyobserver.com.au

As expected, the interest rate was hiked by 0.25% citing better circumstances in the US labor market, and this move was widely anticipated and expected. What’s more important than the effective rate hike, are the comments surrounding this decision. The Federal Reserve has acknowledged the inflation rate hasn’t reached the  2%  yet (well, at least not officially), and it will continue ‘to monitor actual and expected progress toward its inflation goal’. The choice of words is pretty important as the Federal Reserve also said it expects the economic conditions to  ‘evolve in a manner that will only warrant gradual increases in the federal funds rate’. In other words, the American economy isn’t ready yet for more rate hikes, and that’s the main reason why the markets were so enthusiast right after the announcement was published.

Maybe even more important was the statement in the final paragraph, which was a real ‘aha’. Despite increasing the interest rate, pretending the situation of the American economy is much better now, the Federal Reserve said it would continue to reinvest the proceeds of the maturing agency debt and mortgage backed securities as well as the income on existing securities into new ones. This basically is a continuous ‘soft’ Quantitative Easing, something we already pointed out in a previous column, published in October 2014.

Source: Federal Reserve

As you can see on the previous image, the total value of the mortgage-backed securities on the balance sheet of the Federal Reserve continues to increase. Yes, it has slowed down, but if you’d zoom in on the one-year chart, you’ll clearly see the Fed’s balance sheet is still expanding and since the first week of May, the amount of MBS’ on the balance sheet has increased by an additional 2%.