There’s a whole lot of mutual back patting going on at the Fed over supposed success of QE1 and QE2.
But given that QE3 is already out of the bag, where is the upside for the U.S. stock market from here? Isn’t it already fully priced in by now, given that it is common knowledge among everyone except a few clueless Rubes (e.g The Dallas Fed’s Fisher)?
Agustino Fontevecchia, Forbes Staff
Bringing You The Bull And Bear Case From The Markets Desk
3/12/2012 @ 6:47PM
Expect A Quiet Fed Meeting, But $500B QE3 Is Around The Corner
While the Fed isn’t expected to announce any new policy action on Tuesday, the FOMC will probably hint at further easing which shouldn’t be too far away. With a lagging job market, despite strength in the latest non-farm payrolls report, and housing still depressed, the Bernanke Fed will probably deliver an “insurance ease” to keep the fragile recovery on track and hedge itself ahead of fiscal headwinds and external shocks, according to Nomura’s fixed income research team.
On the much commented issue of sterilized bond buying, Nomura’s analysts note it’s essentially an “academic issue.” Bernanke & Co. will probably favor sterilized QE, though, in order to appease inflation hawks and keep a lid on oil prices.
Risk assets hit the road running in 2012, with U.S. and international equities rallying along with commodities. All of that changed on February 29 when Fed Chairman Ben Bernanke, in Congressional Testimony, failed to emphasize how ready he was to deliver QE, sparking a global sell-off that hit U.S. equities (including the financials), emerging markets (as measured by the EEM ETF), and gold, among other assets.
Bernanke’s comments sparked a debate in the investing community, as market players tried to figure out what was next from the Fed. While the consensus toward the end of 2011 was that QE3 was around the corner, improved economic data in the U.S., partial resolution in Europe (as Greece effectively defaulted), and what appears to be a soft landing in China have forced many to reconsider the need for additional monetary stimulus.
The Fed will deliver additional quantitative easing over the next 3 to 6 months, according to Nomura; an opinion seconded by Goldman Sachs’ Jan Hatzius. While the Fed has used relatively more optimistic language in their latest Beige Book and in Bernanke’s prepared remarks to Congress, it continues to stress the economic expansion is still modest, while significant downside risks abound. Furthermore, Bernanke has made clear he still believes housing markets are in the gutter, and that the Fed isn’t delivering on the employment side.
QE will be delivered via purchases of mortgage backed securities (MBS) and Treasuries, with a bias for the former, and will be sterilized in order to appease inflation hawks and critics, Nomura says. With housing prices still looking for a bottom, meager job growth, record-high oil prices, and the probable resurgence of the European sovereign debt crisis in the near future, Bernanke must deliver an “insurance ease” to make sure the economy maintains its “escape velocity,” Nomura’s analysts argue. In other words, the Fed needs to “pump the economy to a high enough level to weather the […] storms that sill lie ahead for the nation.”
Fed involvement in bond markets has been consistent since 2008, suggesting Bernanke will try to avoid the “cliff effect” if they were to stop purchases cold turkey. Operation Twist, by which the Fed sold short-term assets and bought longer-termed securities, is set to come to an end in June.
Thus, the Fed will engage in an approximately $500 billion operation over the next 7 to 9 months, unveiled by the end of Q2, with an 80/20 split between MBS ($400 billion) and Treasuries ($100 billion). Sterilization, which will occur via a small extension of the Twist, term deposits, and reverse repos, will “keep the hawks at bay because a slight rise in front-end rates should support the dollar and reduce oil inflation,” explained the analysts.
The Fed views all three of its latest unorthodox operations as successful. QE1 was the perfect remedy in an emergency situation, while QE2 served to stave off deflation; the Twist worked in putting pressure on longer-rates while giving Bernanke time to let policy take effect.
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