Quantitative easing (QE) may turn out to be a gift that keeps ongiving for the U.S. economy.

As the Federal Reserve prepares to end its third round of bondbuying next week, the central bank plans to hang on to the record$4.48 trillion balance sheet it has accumulated since announcingthe first round of purchases in November 2008.

That will continue to keep a lid on borrowing costs, helping theFed lift inflation closer to its target and providing support to afive-year expansion facing headwinds abroad, from war in theMideast to slowing growth in Europe and China.

Holding bonds on the Fed's balance sheet limits the supplyof securities trading on the public markets, which helps keepprices up and yields lower than they otherwise would be. Thatprovides stimulus to the economy just as a cut in the Fed'sbenchmark interest rate would, according to Michael Gapen, a seniorU.S. economist for Barclays Plc in New York and former Fed Boardsection chief in charge of monetary and financial marketsanalysis.

“Preserving it will continue to support the economy,” Gapensaid. “The Fed message is, 'We think we've done enough to generatemomentum and keep the economy on the right track. Now we're goingto wait and see how things go.'”

The Federal Open Market Committee (FOMC) plans to end itspurchases of Treasuries and mortgage bonds at the next meeting Oct.28-29, according to minutes of the last gathering.

Chair Janet Yellen opened the door to keeping amulti-trillion-dollar portfolio for years, saying a decision onwhen to stop reinvesting maturing bonds depends on financialconditions and the economic outlook. Shrinking the balance sheet tonormal historical levels “could take to the end of the decade,”Yellen said at her press conference last month.

Fed quantitative easing has provided the Treasuries market witha steady and consistent buyer, helping to keep yields lower thanthey otherwise would be. The central bank is now the largest holderof U.S. government securities.

If the Fed continues to hold the securities, it “will continueto put some downward pressure on rates relative to what they wouldhave been had the Fed not had this balance sheet,” said JoshFeinman, the New York-based global chief economist for DeutscheAsset & Wealth Management, which oversees $1.31 trillion, and aformer Fed senior economist. “That's a factor that I think willlinger.”

Lower Yields

The 10-year Treasury yielded 2.26 percent at 9:30 a.m. in NewYork, down from 3.03 percent at the end of last year. It fell to arecord low 1.39 percent in mid-2012. Yields averaged 2.65 percentsince the first QE began in November 2008, compared with 6.95percent before that in data since 1962. The average rate on a30-year fixed mortgage was 3.92 percent this week, still near arecord low 3.31 percent in November 2012, Freddie Mac datashow.

The FOMC said in a supplementary statement at the last meetingthat it expects to stop reinvestments of maturing securities onceit starts raising the benchmark interest rate, a step that policymakers project they will take next year.

Richmond Fed President Jeffrey Lacker, who votes on policy nextyear, later said he opposes continuing to hold mortgage bonds.“This approach unnecessarily prolongs our interference in theallocation of credit,” Lacker said in a Sept. 19 statement.

The Fed's balance sheet includes bonds bought in all threerounds of QE. The first two totaled $2.3 trillion through June2011. The third round, announced in September 2012, differed fromits predecessors in that it was open-ended, with no limit on theamount of purchases and no target date for halting them. The FOMCsaid it would buy $85 billion of bonds a month until the labormarket improved “substantially.”

The jobless rate when QE3 started under Chairman Ben S. Bernankestood at 8.1 percent, and policy makers forecast it would fall to 6percent to 6.8 percent by late 2015. It's now 5.9 percent, nearwhat most officials project is full employment, and monthly payrollgrowth has averaged 209,000 for the past two years, up from a172,000 monthly average during the prior two-year period.

“The objective was to produce a substantial improvement in thelabor market, and that's occurred,” said Keith Hembre, a formerresearcher at the Minneapolis Fed who helps oversee $120 billion aschief economist at Nuveen Asset Management LLC in Minneapolis.“You've got a labor market that's much improved and closer to fullemployment. It's hard to prove what would have happened in theabsence of the program.”

The FOMC began tapering purchases in December 2013, when itslowed monthly buying by $10 billion. It made six more cuts of thesame size at each of the following meetings, saying with each thatit would respond to incoming data. The current pace is $10 billionin Treasuries and $5 billion in mortgage bonds.

“The flexibility allowed the Fed to continue to add stimulusuntil it achieved the goal it set out to achieve,” said LauraRosner, a U.S. economist at BNP Paribas SA in New York and a formerNew York Fed researcher. “That's what made this last oneeffective.”

While most policy makers agree with that assessment, not all ofthem are ready to declare mission accomplished.

St. Louis Fed President James Bullard, who helped lay theintellectual groundwork for QE2 in a 2010 paper calling onofficials to avert deflation by purchasing Treasury notes, said inan Oct. 16 interview with Bloomberg News in Washington the “logicalpolicy response at this juncture may be to delay the end of the QE”amid stalling growth in Europe and declining inflationexpectations. Bullard will vote on policy in 2016.

Low Inflation

The Fed in 2012 set a 2 percent inflation target, saying thatthe pace for the personal consumption expenditures index isconsistent with its longer-run mandate. The gauge rose 1.5 percentin August from a year earlier and hasn't exceeded 2 percent sinceMarch 2012. Policy makers want to avoid deflation, because fallingprices can encourage businesses and consumers to delay spending inthe expectation of further price declines, reducing aggregatedemand.

Boston's Eric Rosengren differs with Bullard in supporting anend to asset purchases. He calls QE3 “materially helpful,” in partbecause it helped boost housing prices. Rosengren votes in2016.

“The fact that we had a very large QE program played animportant role,” Rosengren said in an Oct. 17 interview. “That wasan important component of getting more confident the economy wasgoing to go, that we were serious about returning the economy tofull employment and inflation to 2 percent.”

San Francisco Fed President John Williams, who also supportsending QE, said in a presentation in Washington earlier this yearthat research shows purchases have “sizable effects” on loweringbond yields, though uncertainty remains about the magnitude ofthese effects and their impact on the overall economy. He citedseveral research papers showing QE2 lowered yields on the 10-yearTreasury note by around 15 to 25 basis points.

Bernanke rattled investors worldwide by telling lawmakers in May2013 the Fed may slow buying “in the next few meetings,” spurringthe so-called taper tantrum that pushed the 10-year yield up morethan 1 percentage point in 15 weeks. Now that skittishness aboutstimulus withdrawal is long gone.

“We'll live just fine without QE,” former U.S. TreasurySecretary Lawrence Summers said in an Oct. 21 interview withBloomberg Television's “Market Makers” with Stephanie Ruhle.“Interest rates at the 10-year are now much lower, not much higher,than they were before QE started.”

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