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Saturday November 6, 2010 - 19:59:22 GMT
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Can Quantitative Easing Be Discounted? Should it be (FXA)

Can Quantitative Easing Be Discounted?  Should it be?


In their most reduced form markets are capable of building a discounting mechanism for quantitative easing from the Fed…poll participants on the scale and pace of QE, develop a median or consensus expectation and trade under, over or on expectations.  Surely the Fed was instrumental in encouraging CNBC’s Liesman to do just this…conduct a survey of Fed watchers and economists for estimates of QE so markets could position themselves in front of the announcement and then the Fed could manage these expectations with deep background ahead of the FOMC, the announcement itself and, as we saw on Thursday, an op-ed in the Washington Post by Bernanke.  Indeed as we learned Monday the NY Fed conducted its own dealer survey on QE2 expectations.  It all seems fine…apart from wires running headlines on the aggregate $800-900bln and the net new $600bln which saw some fast trades move asset prices and the dollar before unwinding nearly as fast. 


So why am I asking about discounting QE if the mechanism is there and functioning more or less well?   My hunch is that there are too many moving parts.  There is a dial on QE that can be turned up or down and the diameter of the pipe carrying QE flow can be widened or narrowed in response to more moving parts including the Fed’s economic forecasts (they get adjusted officially quarterly and were readied for this week’s FOMC meeting which we will learn when the minutes are published November 24), economic data, the level of stocks, the dollar and well any damn reason the Chairman wants (politics for instance…domestic and international). 


I know the Fed sees the stock of QE as significant rather than the flow and or timeline (diameter of the pipe).  But markets are the final arbiter of what is important and frankly unless they happen to be economists or curious, then flow and stock matters equally.  Moreover as the employment data today showed, some in the market are adjusting expectations about the current slug of new QE ($600bln) on the notion that more strong data mean the dial for QE2 is turned down.  The reality I think is something quite different.  The Fed is pretty fixed on $600bln increase in the money stock and the bar for reducing this amount is far higher than the bar for increasing it before the program is expected to conclude next June.  In other words Friday’s sign of a healthier jobs market after a decent advance in payrolls is not going to change Bernanke’s QE decision one iota. 


However, the markets should be focused not on the very elevated conditions for changing this slug of QE based on incoming data, but should view how incoming data changes the Fed’s economic forecasts which will decide if there is QE3 at the June 21-22, 2011 FOMC meeting.  Or if the lead time is anything like it was for QE2, then we should expect to hear the Fed drop QE3 about 8 weeks ahead of the June 2011 meeting or roughly in early April (by the way the Fed will revise its economic forecasts at the April 26-27, 2011 FOMC meeting and again at the June 21-22, 2011 FOMC meeting…perhaps why the Fed planned for QE2 to expire in June 2011). 


But perhaps the most serious question markets need to contemplate is whether it is healthy to open a new casino table in the capital markets that has loads of money moving around the planet at light speed based on one massive, unknown policy experiment.  How did the Fed decide $600bln was just right as opposed to $500bln as opposed to $1.5trln or $5bln?  Oh the Dudley corollary…$500bln in QE = 50-75bps of Fed funds rate cut in a non-zero-bound environment…one of those econometric outputs that one study found.  It is shocking.  I can’t help but think that the Fed has (over)sold the entire policy option as an expectations game changer…via a wealth effect from rising risk asset prices including stocks and in time real estate.   This is the Rube Goldberg machine of monetary policy making.  Should markets be betting huge amounts of money on how much QE the Fed will conduct when the efficacy of the tool is highly questionable (could have more costs than benefits), and when the output is unknowable how in hell is the Fed ever going to know how much is the right amount, and how helpful it is to move asset prices on this great unknowable unknown?  How can anyone know for sure that more QE might not backfire and produce lower risk asset prices?


I think the intellectual dishonesty is in the Fed pretending it knows what QE does, how it does it and when it does it, when the Fed does not have a clue.  Why not tell us like it is?  QE is one giant clinical trial with unknown results (good or bad) and encourage markets to avoid this casino table until there is some data in on its effects and consequences.  I am in favor of doing something over nothing if the something is no worse than the nothing.  But don’t feed market propensities to move from the Fed funds casino table to QE table when you don’t even have an idea of how the new game is played. 


It would be a good thing if QE was a Rube Goldberg machine…with a definitive outcome however circuitous.  Call me Rube but the only Goldberg machine I know that works on filling private economic activity holes as deep as the Great Recession’s is fiscal policy.


David Gilmore     



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