Of late market watchers in the U.S. are wondering if the QE3 stimulus will have a comparable effect on markets as the first two rounds of easing. And of course we in the US are nearing the end of the third quarter with earnings season just over the horizon. Around the world the ongoing euro zone financial crisis remains in the center circle of the world’s financial circus. But what caught my eye this afternoon in doing my weekly world market updatewas the ghastly performance of Shanghai Composite.
My friend and occasional guest contributor Chris Kimble came up with the notion of an Eiffel Tower formation as an emblematic way to discuss asset bubbles, which was featured in a guest commentaryfrom last summer. The behavior of the Shanghai index over a two-year period beginning in late 2006 is a classic example, as the first two charts illustrate.
Guest post by Peter Tchir.
I had a strong, even visceral, reaction to the Fed’s announcement Thursday. I was wrong in that I thought they would back down with stocks at highs, housing showing some signs of stability, high gas prices, some real potential ECB intervention in Europe, etc. I was wrong. I was also wrong when I thought the initial muted reaction was a sign that aggressive QE was priced in.
I’ve been wrong before and I’ll be wrong again but something about this really bothers me. I disagree so strongly with the Fed’s decision that I need to take that “anger” into account as I think about the markets and what to do next, so I’m going to try and separate my thoughts in “heart” or what I feel, “head” or what I think, and “gut” or that idea lurking below the surface that is what I should go with since “heart” is too emotional and angry, and “head” is overly compensating for that.
The QE3 Announcement
I disagree with the decision to announce QE. There seemed to be enough going okay that the Fed should have allowed the economy to continue to find its own footing. There is little evidence that QE has been helpful for the economy. QE1 helped a lot, QE2 I’m not so sure about, and what we don’t know, is what the economy would look like now had we not used the Fed’s balance sheet so aggressively. Would we be in better shape now? We just don’t know the answer to that. I can’t help but feel that this is Ben doggedly pursuing a policy he “knows” is right because he wrote the book on it and is very smart. Like a trader with a losing position, here is an academic who just can’t cut his losses. He knows he is right, and he is going to push for it. I think this is as much about personal vindication as anything else. He thinks he knows better than anyone else. He has all these equations that tell him it should work. His stubborn belief in the wealth effect is just wrong. Not only hasn’t it worked, but there are some pretty obvious reasons why it won’t work. Stocks are owned largely by a class who has savings, and isn’t increasing spending based on wealth effect. People are too smart to change business plans when they know the only support central bank policy. The narrow view of “wage inflation” is the only inflation also strikes me as wrong and is where ivory tower illusions cross with Marie Antoinette’s “let them eat cake”. I hate the decision and think it was unnecessary and potentially dangerous.
This US recovery is very different from previous post recession climbs. Marc Chandler, global head of currency strategy at Brown Brothers Harriman, explains to Long View columnist John Authers what is unusual this time, why the Federal Reserve might decide to turbocharge employment with a third round of monetary stimulus or quantitative easing (QE3), and the effect it would have on the dollar.
Video click here.
Say no more. The next QE 3 is priced in. What could possibly go wrong here?
Full video below.
Guest post by Azizonomics.
If the point of the earlier rounds of quantitative easing was to ease lending conditions by giving the financial system a liquidity cushion, then quantitative easing failed because the financial system already has a huge and historically unprecedented liquidity cushion, and lending remains depressed. Why would even more easing ease lending conditions when the financial sector is already sitting on a massive cushion of liquidity?
If the point of the earlier rounds of quantitative easing was to discourage the holding of treasuries and other “safe” assets (I wouldn’t call treasuries a safe asset at all, but that’sanother story for another day) and encourage risk taking, then quantitative easing failed because the financial sector is piling into treasuries (and anything else the Fed intends to buy at a price floor) in the hope of flipping assetsto the Fed balance sheet and eking out a profit.
Guest post by Peter Tchir.
Not Priced In
This is one of the most memorable clips in recent years on CNBC. The Tepper “Balls to the Walls” take on QE2. It was short, simple, and spot-on. He nailed it.
What was interesting at the time was that his belief in how good QE2 would be wasn’t universally shared. Many, myself included, questioned what further reduction of rates would do. I doubted the theory that the money would drive financial assets higher.
I thought the problems were too big for something as simple as treasury buying to “fix”. Then for the next 6 months it seemed, we watched stocks go higher and “POMO” days because the bane of existence to anyone caught short the market. It wasn’t the impact of lower rates, it was flooding the system with money, and the impact on the dollar.
Even when QE2 was announced, the market didn’t react much, because the market didn’t believe QE2 would have much of an impact, so it “wasn’t priced in”.
That cannot be said anymore….
Aside from countless banks calling for QE3 which one has to wonder if their analysis may be slightly biased for personal gain the question remains will we see QE3.
The November 2010 FOMC statement which launched QE2 made it clear why the Fed was expanding their balance sheet by $600 billion.
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities.”
Assuming their basis for future QE has not changed then looking at the data may give us a sense of if and when QE3 will happen.
“To promote a stronger pace of economic recovery”
With rates already at zero the only remaining policy tool with a real chance of achieving this goal is a weak USD that will theoretically stimulate export growth. In the summer of 2010 the USD was approaching $88 whereas today it is $80. In other words the USD has room to run higher before the Fed feels the need to “short the dollar” through policy.
While the shorts struggle, some of the FED members are thinking of QE3….
Meeting participants expressed a range of views on the potential efficacy of policy tools tied to the size and composition of the Federal Reserve’s balance sheet. Many judged that these policies could provide addi- tional monetary policy accommodation by lowering longer-term interest rates and easing financial condi- tions at a time when further reductions in the federal funds rate are infeasible. However, a number saw the potential effects on real economic activity as limited or only transitory, particularly in the current environment of balance sheet deleveraging, credit constraints, and household and business uncertainty about the econom- ic outlook. Participants noted that a SOMA maturity extension program would not expand the Federal Re- serve’s balance sheet or the level of reserve balances, and that the scale of such a program was necessarily limited by the size of the Federal Reserve’s holdings of shorter-term securities so that it could not be repeated to provide further stimulus. A number of participants saw large-scale asset purchases as potentially a more potent tool that should be retained as an option in the event that further policy action to support a stronger economic recovery was warranted. Some judged that large-scale asset purchases and the resulting expansion of the Federal Reserve’s balance sheet would be more likely to raise inflation and inflation expectations than to stimulate economic activity and argued that such tools should be reserved for circumstances in which the risk of deflation was elevated.
Full reading FOMC minutes.