My view is that while the housing market is clearly on the mend, it is going to be a long convalescence, and there is probably little the Fed can do to expedite the process. The major problem for the US economy is a lack of aggregate demand due to prolonged consumer deleveraging. Nothing in the Fed’s monetary toolkit is likely to change that.
The Fed can also do a little to mitigate a more imminent threat to the recovery: the fiscal cliff. Should the pending tax hikes and cuts to transfer payments hit on schedule, this will be a significant blow to a consumer still struggling with too much debt and little income growth. A nominal drop in interest rates, assuming this happens, would do little to cushion the blow.
While the most likely scenario is that Washington reaches a compromise at the last minute, until then the uncertainty will keep the markets volatile and potentially drag down fourth quarter growth. Given recent comments out of Congress, there is also a non-trivial chance that we will, at least temporarily, go over the cliff. If that happens, QE3 will not be a particularly effective parachute.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.