QE3 sounds like a luxury British ocean liner; it's actually an abbreviation for a third round of quantitative easing, which itself is a euphemism for the Federal Reserve pumping more money into the economy. On Thursday, the Fed said it would implement QE3 in the near future.

The mechanics of QE are straightforward: The Fed adds more money to the economy by buying mortgage-backed and U.S. Treasury securities from banks. The securities are paid for with new money the Fed conjures into existence. The Fed's demand for these securities drops the yield on these securities. These lower yields, in turn, are expected to produce lower mortgage lending rates, or at least sustain today's already low rates into the future. 

At least that's the theory. The problem is that price inflation fears – due to the new money – can rise. Should investors' inflation fears trump Fed demand for the aforementioned securities, that means mortgage lending rates could actually go up, thus thwarting the Fed's intended outcome.

In short, there is no sure thing. Many borrowers are waiting on the sideline, anticipating lower lending rates. We think that's a dangerous game, because even if QE3 lowers lending rates, we doubt they will lower them by a significant margin. On the other side of the coin, rates could easily go higher if investor concern switches to inflation from slow economic growth.

Courtesy of Jessica Regan.

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