In the previous iteration of QE following the sub-prime mortgage crisis, the US Federal Reserve generally bought no more than US$80bn of Treasuries each month. From March to April of this year, the Fed’s Treasury purchases peaked at over US$300bn each week.1 The size of this activity was absolutely without precedent.
Meanwhile the central bank has committed to buying at least US$40bn of mortgages and US$80bn of treasuries per month “over the coming months” – i.e. at least through year end. This begs an obvious question: Will this lead to higher inflation? Our view is that the Fed will be slow to remove accommodation and stimulus and this may, therefore, lead to inflation over the long run.
However, there may be some breathing room before inflation becomes a concern. For one thing, there remains enough slack in the system given elevated levels of unemployment. Also, the Fed is now welcoming a modest overshoot of its 2% inflation target to make up for its earlier inability – year on year – to reach that target.2 This would offer more headroom for its balance sheet to naturally moderate rather than having to act to abruptly clamp down on inflation further down the line.
Gautam Khanna, senior portfolio manager, Insight Investment.
1 Bloomberg. Fed Slows Treasury Buying Again to $7 Billion a Day Next Week. 08 May 2020.
2 The Street: Fed- Time to let inflation run hot. August 6, 2020.