The never happening QE3

Minutes from the last FOMC meeting held on June 19-20 were released yesterday. Investors, traders, spread betters, and all other market participants were desperately expecting the report to give some clues that QE3 is being cooked to be served up soon but it seems the FED is just kicking the can down the road (like our European brethren too…).

In the FED statement it was made clear that the committee is much more bearish on the economy than it was on April’s meeting. Growth was cut to 1.9% from 2.4% for the current year and unemployment expectations increased whilst and core inflation expectations were reviewed down. Ben Bernanke’s team does not expect the job market to recover much during this year and even though growth will most certainly occur, it is likely to be at a moderate pace. Everything seems fine until this point for all QE3 believers. The problem is that voting by policymakers didn’t show a real desire to press ahead with more easing at this point. Markets have been rising on the expectations of additional easing being injected in the market but the minutes from the FOMC didn’t point in that direction and so were a major disappointment to investors as todays early price action pays testimony too with a sharp fall right from the get go.

Although QE3 will probably be avoided for now, many still believe Bernanke will announce something at his next public appearance next week at Congress or, maybe at the next policy meeting to be held at the end of July. If that fails, then investors hope that September will be when he will announce QE3 for sure! In the fight between faith and reality, it seems that faith is winning…

The problem is that the costs of implementing QE3 are much higher than it’s benefits at this point. Japan has been trying to get out of a liquidity trap that started in the 90s and isn’t yet over. Since cutting its key interest rate to below 1% in 1995, the Bank of Japan has never able to push it up again. It was shown that the effects of any easing become limited and the Government tried to compensate for the relative ineffectiveness of monetary easing with fiscal policy which just resulted in a skyrocketing government debt that currently sits above 200% of the country’s GDP – the highest in the world.

The FED has also tried the game of buying long term securities in exchange for selling short term debt – so called ‘Operation Twist’. But let’s be realistic, mortgage rates hit a new record low this afternoon at 3.56% and 10-year Treasury bond yields are at 1.48%, a level that is back near historical lows. What can the FED do? What is the aim of buying Treasuries or mortgage securities?

The likelihood of engaging in another monetary easing program decreases the nearer the proximity of the US election to be held in November. The FED would certainly want to avoid being seen as Obama-friendly.

Ben Bernanke is acting as an illusionist, applying his tricks to entertain investors. Sooner or later he will be spotted.

Filipe R Costa