Goldman: "In practice, QE2 is likely to continue well beyond June 2011—at least well into 2012—if our forecasts for unemployment and inflation are close to the mark. We believe that purchases could ultimately cumulate to around $2 trillion...Under our longer-term projections it is easy to come up with models that show no tightening until 2015 or later." In other news, the economy will not recover for the next five years, but under the Centrally Planned Feudal State of Bernanke, the economy is irrelevant. Incidentally, Zero Hedge now believes a $5 trillion QE3 program will be announced by July 2011, when gold is trading at $10,000, the entire Treasury curve is at zero, and stock prices are meaningless courtesy of a DXY sub 50, and every commodity opening limit up daily.

Goldman's prior observations which concluded that a $4 trillion QE is needed now, not in 2011, now, and not $2 trillion as CNBC keeps saying, can be found here.

Jan Hatzius' observations below presented without commentary. Watching this country implode in slow-motion courtesy of a few openly insane economists is self-explanatory.

From Goldman's Jan Hatzius   

QE2: Slightly Slower Pace, But Long Time Frame (Hatzius)

• Today’s statement by the Federal Open Market Committee (FOMC) shows a slightly slower-than-expected pace for the second round of quantitative easing (QE2), with purchases of “only” $75 billion per month.  However, the committee made up for this potential disappointment by signaling a longer-than-expected time period of purchases, cumulating to $600 billion through June 2011.
• In practice, QE2 is likely to continue well beyond June 2011—at least well into 2012—if our forecasts for unemployment and inflation are close to the mark.  We believe that purchases could ultimately cumulate to around $2 trillion.  Moreover, it is likely to take even longer—perhaps several years—before the FOMC starts to increase short-term interest rates, although the outcome as always will depend on the performance of the economy.

We see two main takeaways from today’s FOMC statement:

1. Large-scale asset purchases (LSAPs) are on a slightly slower-than-expected schedule, but will likely grow significantly over time.

In a widely anticipated move to provide more support to economic growth, the FOMC announced that it would purchase $600bn in Treasury securities by June 2011. This is over and above the amount that will be purchased as part of the program to reinvest repayments of principal on agency and MBS, which the committee expects to total $250bn-$300bn over the same period. Thus, overall purchases will be in the $850bn-$900bn range between now and mid-2011. Previously planned purchases for reinvestment will take place as scheduled on Nov 4 and 8, after which the two programs will be combined with the anticipated publication of a new purchase schedule on Nov 10 at 2pm.

While the headline figure for the new program is a bit higher than the $500bn that we and many others had expected, the time period is also longer (eight months instead of six), implying a monthly purchase rate of $75bn. We and others had thought that this figure would be about $100bn.  If we focus on a measure such as the expected stock of Fed asset holdings at a 6-12 month horizon—consistent with our research showing that it is mainly stocks rather than flows of Fed purchases that matter for bond yields—these two surprises probably roughly cancel out.

We believe that the program will grow significantly beyond the initial $600 billion.  Today’s statement says that the committee will "regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability." If our forecasts of a 10% unemployment rate and a further decline in core inflation to around 0.5% by late 2011 prove correct, we believe the committee will continue buying assets well beyond June 2011.  At a minimum, we expect purchases into 2012 and still believe that they could ultimately cumulate to around $2 trillion.  (See “QE2: How Much Is Needed?” US Economics Analyst, 10/42, October 22, 2010.)

2. The statement is consistent with our expectation that rates will stay near zero for a very long time, possibly several years.

One implication of the slightly longer time frame for QE2 is that, at the margin, the likelihood rate of hikes anytime soon has receded further.  If Fed officials are committed to buying assets through June 2011, it is very hard to see how they would turn around a few months thereafter and start hiking the funds rate, barring a massive surprise in the economic data.  This is likely to warrant some additional adjustments in the expectations of many economic forecasters.  Although the OIS curve has already removed any rate hike expectations from the 2011 outlook, the median economic forecast in the October Blue Chip Economic Indicators survey still has the first rate hike in the third quarter of 2011.  This is likely to change in coming months.

How long will rates stay near zero?  Of course, the answer depends on the economic outlook, but at least under our longer-term projections it is easy to come up with models that show no tightening until 2015 or later.  (See “No Rush for the Exit,” Global Economics Paper No. 200, June 30, 2010.)  Fed officials will not commit themselves that far out.  However, it is quite possible that senior members of the FOMC will provide further guidance about the short-term interest rate outlook in coming months to explain to market participants just how distant the prospect of interest rate hikes really is.  This could take the form of a version of our Taylor rule or policy reaction function analysis, with a strong implication that even the current market expectation of rate hikes in 2012 may well prove premature.

What's amazing about the latest bout of quantitative easing is the total lack of pretense. By that we mean Bernanke isn't even pretending that that QE would actually benefit the real economy.

We noted yesterday that buy concentrating buying at the short end of the yield curve, Bernanke was punishing savers (pinning short-term rates to the mat) and bailing out banks (keeping the yield curve steep).

But check out this line from his op-ed in the Washington Post:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action.

Amazing. Bernanke's evidence of success is the market pump-up. There's not necessarily anything real behind it (though the economy is improving, at least against expectations), but Bernanke's just happy to see the market rise.

Of course, he hopes the wealth effect from stocks will spill over into real economic gain, but it still reeks of manipulation and intentional bubble-blowing.

There was nothing in the Fed press release yesterday that was really surprising. In fact, the market’s initial dramatic reaction (all over the map) was what’s most surprising. The Fed is going to be buying $600 billion of Treasuries (in the 5-10 year part of the curve) through mid-2011 and another $250-300 billion via coupon reinvestments, which they were going to do anyway.

The “number” that was key for the markets is that $600 billion figure, which is about $75 billion per month. That is in the middle of consensus expectations of $50-100 billion. Not “shock and awe”, based on what was broadly expected, but not “light” either considering that the economy, at least so far, has managed to avoid double-dipping.

For all the excitement, this further expansion of the Fed’s balance sheet will add between 0.25-0.5% to real GDP growth; however, this will take the size of the Fed’s balance sheet to a Japanese-style 20% of GDP!
What the Fed is clearly trying to do is reflate asset values in order to generate a more positive wealth effect on personal spending and pull the cost of debt and equity capital down in order to re-ignite business “animal spirits” and hence corporate investment and hiring. In a balance sheet or deleveraging cycle, success is not always guaranteed even by the most aggressive of monetary policies.

Through its actions, the Fed creates excess reserves in the banking system. But with one-third of the household sector gripped with a sub-620 FICO score, 1-in-7 mortgage debtors are either in arrears or in the foreclosure process, and with an estimated 25% of homeowners “upside down” in their mortgage (negative equity), there is at least some non-trivial probability that, as was the case with QE1, there will be no visible impact on the willingness to borrow, the money multiplier or velocity, which is what we would need to see to declare this radical policy experiment a success.

In a nutshell, with core price trends running below 1% and the economy past the peak of growth for the cycle, the Fed is not far off the mark in its deflationary concerns. The critical aggregate here is the unemployment rate — policy is aimed at redressing the glaring “gap” or chronic excess capacity in the labour market.

Go back two years ago when the Fed was on the brink of cutting the Fed funds rate to zero and the central bank was expecting to see, by now, a 7% unemployment rate. On the eve of QE1 in the opening months of 2009, the Fed’s base case was an 8% jobless rate by now. Instead, the jobless rate is sitting near 10% and only an atypically low participation rate has prevented the official unemployment rate from being higher than 12%. Moreover, counting in the vast degree of “under- employment”, the real unemployment rate is closer to 17%.

The one asset that has responded miserably to the Fed announcement is the long bond — it is getting clobbered, in part because the Fed bond buying is in the mid-part of the curve. Looking at the huge spread between 30-year bonds and the 5-year note, if inflation does not rear its ugly head, the best risk-reward is now really at the long end, which is universally despised and may be one reason to like it even more!

The U.S. dollar is on the verge of breaking down — the recent countertrend rally in the DXY may well be snuffed out quickly. The 50, 100, and 200-day moving averages in gold are all in major uptrends despite the corrective phase from overbought levels.

It’s difficult to see how equities can rally on this Fed move alone or the election results for that matter seeing as a GOP victory in the House and QE2 had both been widely discounted in recent months. There have been no surprises here over the past 24 hours. Just confirmations on what had already been priced in.

Meanwhile, risk assets from equities, to credit, to emerging markets have, in recent months, become correlated with a weaker U.S. dollar in an unprecedented fashion. A weaker dollar, in turn, fits in very well with Ben Bernanke’s reflationary strategy by cheapening exports and buying jobs from abroad, not to mention adding extra impetus to foreign-currency translated corporate earnings. The question is whether the dollar’s descent becomes destabilizing or what the responses to this overt weak dollar policy will be in other parts of the world. Currency wars tend to lead to trade wars and trade wars do not tend to end very well (gold being an exception).