The Fed's preferred voicebox, WSJ's Jon Hilsenrath is out with another article discussing what the imminent QE2 may look like. The summary is that contrary to expectations for a "big bang" intervention, the Fed will instead do $100 billion in QE a month until such time as it deems fit. A few observations on this article.
- First, this is not news, and was disclosed by Ambrose Evans-Pritchard about a week earlier.
- Second, $100 billion a month is precisely what a $1 trillion QE action would amount to, as the Fed can not possibly do more than $25 billion of POMOs a month without thoroughly blowing up the stock market, courtesy of endless excess liquidity.
- Third, as we discussed previously, not even Primary Dealers have enough Treasurys in inventory to satisfy this much demand (in fact, according to the New York Fed as of Sept. 15 PDs only had just over $60 billion in UST holdings on hand).
- Fourth, piecemeal monetization of Treasurys will have a smaller impact on overall rates and MBS prepayments, both of which are key goals for the Fed. This is stupid because as Hatzius notes: "The more you commit to large amount of purchases up front, the bigger effect you're going to get." And if there is one thing the Fed is, it has never been shy about intervention.
- Fifth, what will be the metric for the Fed to determine when enough is enough? Will the Fed merely set a DJIA threshold past which it will consider it's job solver (and forget all that bullshit about inflation and unemployment targets - even the San Fran Fed said that unemployment is about to go back above 10% and stay there for 2011). So what will be the Fed's cut off for indirect equity market intervention: 12K? 15K? 36K? And what about oil: $100? $200? Revolution?
- Sixth, again as we discussed earlier, we most certainly expect rates to plunge upon any announcement, and MBS prepayments to spike. This means that the Fed will be forced to not only purchase $100 billion in USTs per month, but may have to almost double that to account for its shrinking holdings of MBS/Agencies.
- Seventh, and most important, is Bullard's admission that even $100 billion of QE a month (and possibly up to $200 billion assuming prepays) is equivalent to outright monetization (as it adds up to $1.2 trillion a year) "Mr. Bullard says the idea of doing more than $1 trillion of purchases a
year "gives me pause" because that is how much net debt the Treasury
will issue this year, meaning the Fed would be financing it all." In other words, the Treasury will have to issue ever more debt to satisfy the open mandate for demand (possibly all the way up to double the $1 trillion per year in issuance). That should not be a problem. What is however, would be the implicit lie that Tim Geithner will have committed by swearing on live TV that the Fed will not monetize debt. Alas, as Bullard confirms, the Fed would be doing just that. Which incidentally is precisely what the Weimar government was doing before the hyperinflation train took off.
In other words, Hilsenrath's speculation today does nothing to change our conclusion that very soon, the Fed's ravenous demand for assets will result in a break in the rates market, and will take equities, commodities (inversely) and last, but not least, the dollar with it.