And let the rally begin…
Today’s global rally not reacting directly to this round of QE2, but to the new reports from Goldman Sachs that additional rounds of QE are on the way that could equate to a total of $2 trillion dollars.
QE2: Slightly Slower Pace, But Long Time Frame (Hatzius)
- Today’s statement by the Federal Open Market Committee (FOMC) shows a slightly slower-than-expected pace for the second round of quantitative easing (QE2), with purchases of “only” $75 billion per month. However, the committee made up for this potential disappointment by signaling a longer-than-expected time period of purchases, accumulating to $600 billion through June 2011.
- In practice, QE2 is likely to continue well beyond June 2011—at least well into 2012—if our forecasts for unemployment and inflation are close to the mark. We believe that purchases could ultimately accumulate to around $2 trillion. Moreover, it is likely to take even longer—perhaps several years—before the FOMC starts to increase short-term interest rates, although the outcome as always will depend on the performance of the economy.
It goes further, Hatzius put out a brand new analysis, which performs a top down look at how much monetary stimulus is needed to fill the estimated 300 bps hole between the -7% Taylor Implied Funds Rate (of which, Hatzius believes, various other Federal interventions have already filled roughly 400 bps of differential) and the existing 0.2% FF rate. Using some back of the envelope math, the Goldman strategist concludes that every $1 trillion in new LSAP (large scale asset purchases) is the equivalent of a 75 bps rate cut (much less than comparable estimates by Dudley, 100-150bps, and Rudebusch, 130bps). In other words: the Fed will need to print $4 trillion in new money to close the Taylor gap.
The market rally over the next couple of months will be discounting these exorbitant amounts of Fed stimulus just as QE2 speculation drove markets 14% higher since late August.
It’s our feeling that Goldman put this report in light of the Fed’s statement that they will “regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
So herein lies the rub. Talks of QE3, QE4 essentially buy the economy time as this round of stimulus works its way into the economy. QE3 and QE4 may not very well be needed, but in their efforts to ultimately suck sidelined investors back into the markets they need to provide scenarios the market hasn’t already discounted. Let’s remember what Bob Farrell pointed out about investor psychology, “in the end what draws people back to stocks when they have a high degree of distrust, is rising prices. The fear of missing out, at least temporarily, overcomes the fear of losing.”
QE2 and beyond hopes to spur economic activity by generating more ‘wealth’ for investors through rising asset prices and by cushioning the banks profits with a steepening yield curve so that they can lend, lend, lend.
While QE2 had been priced into the markets, speculation of additional rounds are making their way through and taking the markets higher in the interim.
On a side not, even Roubini has jumped in on the opportunity to offer his additional QE scenarios:
QE3: more Treasuries purchases by the Fed in 2011 once QE2 has little traction on deflation risk and anemic growth
QE4: another round of reckless tax cuts pushed by the GOP financed by Fed monetization of deficit (effectively an helicopter drop of money)
QE5: The Fed targeting the 10yr Treasury yield at 1% by committing to buy unlimited Treasuries at that price/yield as it did in the 1950s.