Fed And BOJ: Credit Easing Vs Quantitative Easing

After the 2-day FOMC meeting, the Fed announced a massive quantitative easing plan which includes purchase of up to $300B of long term Treasury securities over the next 6 months as well as expansion of the mortgage debt purchase program to $1.450 trillion in total - $1.25 trillion in agency MBS, from $500B, and $200 billion in direct agency debt, from $100B.

At the same time, policy rates will be kept at 0-0.25% 'for an extended period'. The statement was changed from the previous 'for sometime'. Moreover, the Fed stated that the TALF will be launched this week and is anticipated that' the range of eligible collateral for this facility is likely to be expanded to include other financial assets'.

According to NY Fed, the Treasury purchase program will start late next week and will be concentrated in nominal securities with 2-10 years' maturities. Smaller purchases will occur across the entire nominal Treasury and TIPS curve.

The announcement of a wide-ranged easing plan yesterday will definitely expand the Fed's balance sheet, to probably $4 trillion. However, it also indicated the policymakers' determination to revive growth as economic conditions have deteriorated rapidly since the last meeting. From the post-meeting statement, we observed the Fed has turned less optimistic on the economic outlook. After the Jan 28 meeting, the Fed stated 'conditions in some financial markets have improved'. However, such sentence disappeared from the latest statement. Also, although the central bank expected 'policy action, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth', it did not mention that growth will 'begin later this year' as was mentioned in the previous statement.

The market has generally supported the Fed's aggressive action to 'employ all available tools to promote economic recovery'. 10-yield Treasury fell sharply by 53 bps, the dollar plunged against major currencies. Against the euro the pound, USD dropped to as low as 1.35 and 1.43. Against the Japanese yen, the dollar also slid to as low as 95.66.Stock markets rallied with Dow Jones Industrial Average gained 1.23% to close at 7486.6 and the S&P 500 added almost 2% to settle at 794.4.

A day ago, the Bank of Japan also announced an asset purchase program. Apart from keeping interest rate low at 0.1%, policymakers in BOJ unanimously voted to increase the purchase of its long-term JGB to 1.8 trillion yen per month from the original 1.4 trillion yen per month as 'continued provision of substantial liquidity is required to ensure stability in financial markets'.

The expansion in Rinban operation was above market expectation (the market had anticipated an increase of 0.2 trillion per month) as it reflected the central bank's concern on deflation and economic contraction in the nation. In December's meeting, the Bank of Japan indicated they were 'NOT considering any further increase for the time being' after the bank raised JGN purchase to 1.4 trillion yen per month from 1.2 trillion yen per month. The change this time was likely due to disappointing economic data released recently.

However, the quantitative easing measures adopted by Japan remain too conservative as shown by the flat yield curve and high 3-month interbank rate. We do not expect the financial market and economic outlook will have significant change after the policy. Rather, economic recovery will be seen if evidences show that the domestic production in Japan has bottomed or US economy has signs of turnaround.

The major difference between the FOMC and the BOJ's easing plans is that the Fed focuses more on giving support to the mortgage lending and housing market while the one by BOJ is more on increasing reserve to the banking system. Therefore, chairman Ben Bernanke termed his unconventional easing policy as 'credit easing' and the success of which is determined by credit spreads and credit availability. The Fed's policy works through the asset side of the balance sheet, while the traditional approach works through the liability side.
According to Bernanke, the mix of loans and securities in the balance sheet is crucial for the credit conditions. However, in Japan's approach, 'the composition of loans and securities on the asset side of the balance sheet is incidental'.