Reasons Why The Fed Will Not Announce QE 3 This Friday
Stock-Markets / Quantitative Easing Aug 28, 2012 - 02:03 PM GMTBy: Graham_Summers
The biggest even this week is Ben Bernanke’s Jackson Hole Speech which will take place on Friday August 31. It was at Jackson Hole in 2010 that Bernanke hinted at QE 2. With that in mind, many investors believe that the Fed is about to unveil or at least hint at a similar large-scale monetary program this Friday.
We, at Phoenix Capital Research, disagree for three reasons. Number one, stocks are at or near four-year highs. With stocks at these levels, there is little reason for the Fed to use up any of its remaining ammunition.
Secondly, food prices are soaring due to the worst drought in 56 years. Some 63% of the lower US 48 states are experiencing a drought. As a result of this, the USDA has said that 50% of the US’s corn crop will be in poor to very poor condition. Soybeans are in similar shape.
Thirdly, gas prices are near their all time highs.
As far back as May 2011, Ben Bernanke admitted publicly that the consequences of QE (higher food and energy costs) were outweighing the benefits (higher stock prices).
With stocks where they are today and food and energy prices where they are today, there is little reason for the Fed to unleash QE 3 or any large monetary program. Indeed, if the Fed were to do so, it would most assuredly cost Obama the election as the ensuing inflationary pressure would hit voters’ pocketbooks.
With the election less than 100 days away and Mitt Romney and the GOP increasingly targeting the Fed and specifically Bernanke as a problem, the Fed isn’t going to do anything that could risk Obama losing his bid for re-election. This is especially true given that there really isn’t a sound argument for more QE at this time: food prices, energy prices, and stocks are high, while interest rates are at or near all time lows.
There is a fourth and final reason why QE is not in the cards. QE is a policy through which the Fed prints money to buy Treasury or Agency debt from the banks. The problem with this is that these bonds are the senior most assets that the banks use to backstop their trading portfolios.
In the case of the TBTFs, these banks only have $7 trillion in assets back-stopping over $200 trillion in derivative trades. The last thing these banks want is to swap out their senior most assets (Treasuries and Agency bonds) for more cash (remember the banks are already sitting on over $1 trillion in cash in excess of their required reserves).
In simple terms, the banks don’t want cash. They want bonds, which they can use to leverage up their trading portfolios: their primary source of revenue with interest rates at or near zero.
Indeed, Bernanke has all but admitted this recently, saying “I assume there is a theoretical limit on QE as the Fed can only buy TSYs and Agencies… If the Fed owned too much TSYs and Agencies it would hurt the market.“
Why would it hurt the market? Because the banks NEED assets/collateral. And QE takes this out of the system.
For this reason, we believe it is highly unlikely the Fed will announce QE at this time. There really is no reason for it to do especially since QE would in fact hurt the big banks: the very institutions the Fed has been trying to prop up.
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Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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