With the recent change in FED “speak” strategy, more transparent communication and the new composition of voting members within the FOMC – kingdom of the doves and the last hawk having left the building – market speculation is rising that a new round of QE3 will be announced very soon. On the desirability of such a new program and expected effectiveness, media consensus is however rather neutral, even pessimistic. And this stems from the fact that the overall results of QE2 (600 bio USD extra printing nov/10- june/11) did not really generate the benefits in terms of economic growth and job creation. Asset prices did go up in the first half of 2011 but that came at a cost of higher commodity prices and thus lower “core” consumer spending. Bernanke blamed this on the Arab Spring but I think he confused cause and effect wrt the commodity price lift off.
Today’s comments on a potential QE3 are pretty much the same. El Erian (Pimco) and especially Nomura’s perma bear Janjuah are pretty straightforward on possible indigestion effects : “If it is simply a repeat of QE2, it will make the commodity problem even worse, it won’t help the economy and creates a bigger inflationary problem going forward. So the benefits could be self-defeating because it will ultimately raise governments’ borrowing cost”. And according to Carmignac, “the marginal effect of QE is decreasing progressively with the weight of debt on the FED balance sheet increasing”. In 2 years time, the FED’s balance sheet almost doubled to 20% of GDP, something Japan did in a time period of 5 years (2001-2006). Useful or not, desirable or not, the point is that QE3 might be introduced for other reasons : pure necessity. As was the case with QE1 (Q2 2009). Let’s have a look at the following chart :
In the last 4 months of 2008, both the S&P500 (orange line) and 10y US rates (white line) went lower with 10y rates hitting rock bottom in December 2008 (2%). In the first quarter of 2009, stocks went down deeper with the S&P hitting its low of 676 early March. However, flight to quality did not prevail in Q1 with 10y rates moving up from 2% to 3% in no time. And it wasn’t until QE1 was announced in March 2009 that 10y rates more or less stabilized.
Some might argue that the FED has no need for yet another QE bazooka in order to stabilize rates, a kind of pre-emptive strike in anticipation of potential higher rates. I am not quite sure about that. Lately, a lot has been said about the giant amounts of refinancing knocking on the door of 2012/2013. And most attention has gone to European governments (eg Italy) and banks facing a couple of hundred billion of euro refinancing during the year. In the case of European governments, in between 20 and 25% will reach final maturity before 2014. We have already suggested in previous blog postings that the ECB LTRO auctioning -150 bio eur Dec/11 and a similar amount coming up in Feb/12 – is exactly serving this purpose, ie pre-financing the banking sector roll-over. But nobody mentions Uncle Sam and it’s insatiable public finance hunger. Just have a look at the following graph depicting the time maturity composition of US public debt :
And yes, we have some hefty 2750 bio USD of T-bills and bonds reaching final maturity in 2012. This briefly means an average weekly Treasury auctioning of about 55 bio USD in bills and bonds. So markets might indeed get indigested in the short term by yet another auctioning ad infinitum. R…