With less than a month to go before the end of the Federal Reserve's second $600bn (£367bn) programme of quantitative easing, and the recovery of the world's largest economy again appearing to falter, traders have begun debating a subject that appeared unthinkable just a few weeks ago: could the US be in need of a QE3?
A trio of Fed officials speaking in the past 48 hours made no mention of extending the central bank's programme of bond-buying for a third time, in the hope of keeping interest rates down and boosting lending.
But neither did they talk up the "exit strategies" that have dominated Fed meetings in recent months, where policy-makers had started to examine ways to unwind the unprecedented monetary stimulus they have administered since the financial crisis.
Financial traders, meanwhile, have driven yields on US Treasuries to new lows in the past few days, when the imminent end of QE2 might have been expected to push rates up. The reason is a slew of disappointing economic data, including housing market indicators, consumer confidence surveys and manufacturing reports – all of which have led market players to examine what options the Fed might have to stimulate the economy if it becomes necessary.
The introduction of QE2 last summer, on the heels of the first $1.75 trillion round of easing launched at the depths of the financial crisis, was met by significant public criticism and concern that it could trigger inflation. QE involves printing money to buy government debt.
John Williams, the chairman of the San Francisco Federal Reserve, defended QE2 in a speech at the regional bank's headquarters, estimating it would have added 3 per cent to US GDP and 3 million jobs by the second half of next year. Sandra Pianalto, the chairman of the Cleveland Fed, said that while the US economy is on a firmer footing, "growth may be frustratingly slow at times".
Speaking in Japan, the Fed's vice-chairman, Janet Yellen, said: "The current accommodative stance of US monetary policy continues to be appropriate because the unemployment rate remains elevated and inflation is expected to remain subdued over the medium run."
The quantity of money pumped into the economy under QE naturally declines as the purchased bonds mature, but economists and fund managers believe the Fed will move to keep the stimulus going by replacing maturing bonds. For now, the consensus is that the central bank is unlikely to launch an explicit QE3, though the odds have shortened as the economic data has underwhelmed. Today's unemployment figures for May are nervously anticipated.
Mohamed El-Erian, the chief executive of the bond fund manager Pimco, said the QE2 had not been a success, and should not be repeated. "Simply throwing more money at the economy doesn't seem to be enough," he said in a television interview.
Pimco this year sold all its holdings of US government debt, expecting prices to slide and interest rates to soar as QE2 ends at the end of this month. So far, this has proved a losing bet. Yesterday, the yield on a 10-year Treasury remained below 3 per cent, lower than at any point this year.
Larry Shover, a senior adviser to the Illinois hedge fund Efficient Capital Management, said the Fed may wish to be more "evasive" in a new round of monetary assistance, given the controversy of QE2. "The Fed has a number of different tricks up its sleeve that it can use without calling it QE3," he said.
One suggestion would be to try to manipulate the yield curve, the difference between interest rates on bonds of different duration. The spread between interest rates on two-year Treasuries and 10-year Treasuries has compressed to such an extent that banks are finding it hard to make money by borrowing short-term and lending longer-term at higher rates, something that has been crimping lending activity.
Mr Shover said the Fed could widen that spread by selectively selling longer-term Treasuries. "Banks risk losing money on such a tight spread. By artificially widening that spread back out, banks can be profitable again."
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