What to Expect From QE II
By David Moenning , October 28, 2010
http://seekingalpha.com/article/232970-what-to-expect-from-qe-ii#comments_header
Nearly everyone in the game expects Ben Bernanke's gang to announce another round of quantitative easing (defined as the direct purchase of bonds) at the conclusion of the November 3rd FOMC meeting.
What we should expect from the program?
First,
the expectations in the markets are for the FOMC to announce the commencement of a bond buying program that will total somewhere in the vicinity of $300 billion to $500 billion by the end of January. Anything short of $500 billion could be viewed as a disappointment to traders.
Second,
we would expect the Fed to say that they will assess the situation at the end of January and decide from meeting to meeting whether “additional accommodation” is needed.
Third,
“So, what’s the plan? We expect to see the FOMC make purchases of bonds in the 2-year to 10-year range. The goal is to push longer-term interest rates lower in the hope that investors will stop hoarding short-term bonds and take more risks by moving out the yield curve, take on more credit risk, and investing in equities and/or real estate.”
Fourth, risk of inflation?.
“Recently, we’ve heard Ben Bernanke utter words that most of us thought we’d never hear – that inflation is too low. Thus, another intention of QE II is to put a little inflation back into the mix. The idea here is that some inflation would help the real estate and stock market, which, in turn, would help homeowners repair their balance sheets.”
Fifth, opposition?.
What their arguments? a. that QE is an unproven instrument; b that the problems in the economy (structural unemployment, taxes, regulation, healthcare costs) cannot be rectified by the Fed or monetary policy; c. that the idea of “a little inflation” is akin to being “a little pregnant.”
Sixth, Counter argument?.
This is a horse of a different color: a. “the goal of this round of quantitative easing is very different than what we saw the Fed implement during the credit crisis (2008). The first round of QE was aimed at stabilizing the credit markets and adding liquidity. Recall that the credit markets were almost completely frozen at the end of 2008, thus the Fed’s goal was to thaw things out by coming in and being a buyer.
b. this time around the goal is completely different. In short, the QE II is about economics and not about bank lending. As Bernanke pointed out in Jackson Hole, this effort is about forcing investors to take more risk [in the short term] and stop hoarding cash.
Seventh. Will it work?
We won’t know the real answer for quite some time. However, by pushing longer-term interest rates down, mortgage rates and bank lending rates should come down as well.
d. Risks?.
They are already apparent as the markets have largely priced in the launch of QE II. We’ve seen the US dollar tumble, commodity prices rise, and interest rates fall. The fear is that QE II will create more inflation than intended and potentially cause excessive buying in the commodity and emerging equity markets.
e. Good intentions?.
Bernake’s intention is “avoiding the kind of deflation that plagued this country during the 1930’s and the downward spiral seen in Japan over the past 20 years. Thus, Bernanke & Co. would seem to welcome a rise in inflation now and assume that they can worry about any “unintended consequences” of the QE II later”.
See original doct in http://seekingalpha.com/article/232970-what-to-expect-from-qe-ii#comments_header
About the author: David Moenning is a the proprietor of TopStockPortfolios.com. In addition to providing free and subscription-based portfolios on TSP, Dave is a full-time money manager and the President and Chief Investment Strategist of a Chicago-based SEC Registered Investment Advisory firm.
Related article:
“Pimco sells US Treasuries ahead of QE2”. 14 Oct 2010 .-
http://www.telegraph.co.uk/finance/economics/8063303/Pimco-sells-US-Treasuries-ahead-of-QE2.html.
The Federal Reserve bought $300 billion of Treasuries last year under the QE policy 1 and is expected to buy another round. Pimco, manager of the world’s largest bond fund, is selling US Treasuries in the expectation that a fresh helping of economic stimulus from the Federal Reserve will have little impact. He worries over record-low Treasury yields that has seen in the demand for US bonds in decline as investors seek for higher returns in commodities and equities.
Anticipation of more Fed stimulus to boost the world's biggest economy pushed the dollar to a 10-month low against a basket of currencies and the gold price to a new all-time high of $1,380.32 an ounce. Crude oil and grains also rose.
"There is practically no interest rate, so everyone is rushing into commodities and the stock market,"
Pimco believes developed economies will suffer slow growth and below average returns and is focusing on sovereign debt in emerging markets, such as India and China. //
“Even if the QE [quantitative easing] process is large and rates decline further, in our view we’re approaching the end of the bond market rally,” Mr Hodge said. //
If the Fed announces a QE program after the next meeting, how might the markets react? I suspect the Treasury market would sell off on the view that it was better to have travelled than arrived .. they are not likely to resist taking profits."
He said QE is likely to be seen as positive for economic growth and corporate earnings, which would benefit shares.
"Valuations have swung so far in favour of equities that, even with some rise in bond yields, the valuations are still likely to favour them strategically as the asset of choice - even if it led to higher yields on bonds," he said.
As for gold, he said: "The bubble will continue to inflate but [soon is going to get the top, it reads so in the original doct] who is going to call the top."
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“Fed Easing to Keep Dollar Weak Next Month” said John Taylor, founder of FX Concepts LLC, the world’s biggest foreign exchange hedge fund.
By Allison Bennett and Erik Schatzker - Oct 28, 2010.
http://www.bloomberg.com/news/2010-10-28/fed-easing-to-keep-dollar-weak-through-november-fx-concepts-taylor-says.html
The dollar declined 0.8 percent to $1.3879 per euro. “The dollar will be weak, probably through the month of November, as we get a feel for the program,” Taylor said. The U.S. currency has tumbled 8.7 percent against its European counterpart since Aug. 27 when Fed chairman Ben S. Bernanke pledged in a speech in Jackson Hole, Wyoming to safeguard the economic recovery through the purchase of Treasuries.
“As soon as the Jackson Hole issue, the QE2 issue came out, you sell the dollar,” Taylor said. “The best measure of when to stop selling the dollar is when the QE2 effort is matched by problems in Europe or problems in China.”
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Next:
Can Foreign Governments Take Advantage of QE2? October 15, 2010 By Michael James McDonald. http://seekingalpha.com/article/230188-can-foreign-governments-take-advantage-of-qe2
Can Foreign Governments Take Advantage of QE2?
October 15, 2010
By Michael James McDonald.
http://seekingalpha.com/article/230188-can-foreign-governments-take-advantage-of-qe2
There is one story of the many epic encounters that Cornelius Vanderbilt had with Daniel Drew and Jay Gould in the late 1800's that I always found funny. It's about one price war they had in their continuing competition to be "top dog" in cattle shipments. Both sides owned railroads. Alternatively, each reduced cattle shipment prices from ten cents a head, to four cents, to two cents and finally, Vanderbilt went to zero, expecting that would be it and put their railroad out of business. However, he suddenly learned that Jay Gould had purchased every head of cattle he could find, making a small fortune shipping them all to Chicago at Vanderbilt’s expense.
Does QE2 make a similar type financial joke in the T-bond & currency markets possible?
The primary way foreign governments maintain a trade advantage is to buy U.S treasury bonds. This keeps their currency trade advantage by preventing a dollar decline since these purchases act like American exports offsetting our imports of their goods. This accumulation of treasuries begins to show up in the yearly US government report called the "International Investment Position", a section of which is shown below.
click to enlarge abrir la pagina web arriba para ver el cuadro
It shows foreigners now own over 21 trillion dollars of American assets. Of this (shown in red) foreign governments own 3.59 trillion in treasury issues and foreign individuals another .826 trillion. Here’s the rub. Nothing comes for free. While purchasing these bonds allowed them to maintain a low exchange rate and export a lot of stuff; it only forestalls the inevitable. As soon as they try to reclaim this back into their own currency, it works against them in two ways.
First, selling American bonds works just the opposite as purchasing them; now it lowers the dollar, shrinking the bond portfolio's valuation in the home currency. Second, selling large positions in treasury bonds also drops the intrinsic price of the bonds since there are few buyers. The effect of both bond and dollar price declines could cause combined losses of 40% to 50% on their 3.59 trillion dollars. It also hurts their trade. This pain has to come someday; it's inevitable and the longer it's put off the bigger the pain will be. But maybe QE2 allows them a "once in a lifetime" opportunity to do it all now at minimal loss (and pain).
Is QE2 creating unseen consequences and financial opportunities for others (like Vanderbilt)?
First, QE2 gives them a buyer for the bonds and also someone who wants to support the price – the US government, who is simply printing money to purchase bonds. Second, before they sell, they can purchase OTC currency options (financial derivatives shown in blue) to guarantee a good exchange rate from someone who doesn’t know their intentions. Which means they could convert the dollar proceeds into Yuan or Yen or whatever, at a rate better than the market would give them since if they tried to use the currency markets their size alone would push conversion prices against them. Instead of losing from 40% to 50% it might be reduced from 10% to 15%.
If this is both possible and feasible and they end up trying to do it, expect a very large price drop in the dollar from QE2. The counterparty to the currency options (probably a large international bank) is the one who would create and stomach the big currency losses that the foreign country passed to them.
Not long ago the Fed's actions could be made in isolation. I think very soon they will realise that what they can now do depends more on global factors than the state of the Amercian economy.
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