Goldman Finds That QE2 Is Now Mostly Priced In

Tyler Durden's picture

Some more observations on what will be the most contested capital markets topic through November 3. Goldman's Sven Jari Stehn has attempted to do quantify the response to the question that most equity and bond investors are banging their heads over: namely, how much of QE2 is already priced in. Goldman's findings: "a purchase program of about $1tr may now be reflected in 10-year Treasury yields, the three-month Libor rate and the dollar." Of course, there is a qualification: "This finding, however, is sensitive to when we think the market started pricing in QE2; equity price gains since Bernanke’s Jackson Hole speech have been more pronounced." Then again, there are those who will say that using QE1 as a framework for any comparative efforts is useless, as QE1 had little to no effect. While that may be true for the general economy (read Main Street), it certainly helped liquidity conditions on Wall Street: "our estimates suggest that “QE1” eased financial conditions significantly through lower long-term yields, higher equity prices and a weaker dollar." In other words Wall Street and Corporate America 1, Everyone else 0. But we knew that long ago. So here are Stehn's full findings, which may disappoint all those who are hoping for the absence of a sell the news event at 2:15 pm on November 3 (and will certainly disappoint all those who are hoping there will be no broad flash crash if there is no news): in a nutshell double the upcoming $1TR QE2 is already priced in in bonds, and half of it: in equities. Using such Columbia Business School-approved scientific methods as law of averages, Gaussian distribution, and pig vomit, which serve as the basis for every flawed economic theory, this means QE2 is now fully discounted.

First, in "QE2: How Much Has Been Priced In?" Stehn attempts to quantify the impact of QE1 on Wall Street bonuses as determined by such much less relevant factoids as bond spreads, and equity levels.

The Federal Open Market Committee (FOMC) is widely expected to announce renewed asset purchases at its November 2-3 meeting.   We regard an initial announcement of $500bn as likely but anticipate that the size of the purchase program will ultimately total at least $1tr.

The experience with the first round of asset purchases suggests that “QE2” could have substantial effects on asset prices.  Although the uncertainties are huge, our estimates suggest that “QE1” eased financial conditions significantly through lower long-term yields, higher equity prices and a weaker dollar.  (See “Unconventional Fed Policies and Financial Conditions: How Tight a Link?” US Daily Comment, August 17, 2010.) Given the difficulty of identifying the quantitative effects of asset purchases we estimated the effects on financial conditions over three different horizons (we considered 1-day changes, 30-day changes and a permanent “levels” effect).  The average across these three horizons suggests that financial conditions—measured by our financial conditions index, GSFCISM—eased by around 80 basis points (bps) per $1tr of announced purchases (see first part of the table below).  This easing in financial conditions is due to a 49bps decline in long-term yields (contributing 27bps to the decline in financial conditions), a 7bps reduction in the three-month Libor rate (worth 3bps), an 8% boost to equity prices (40bps) and a 2% dollar depreciation (10bps).  We further found that the 10-year Treasury yield fell by around 25bps per $1tr of announced purchases, suggesting that roughly half of the decline in the long-term yield—which is the sum of a 10-year swap rate and a 10-year credit default swap spread—was due to a narrowing of spreads.

Next follows a pretty table that argues convincingly that anyone who made a bonus less than $1 million last year must run a Fund of Funds and appear constantly on Fast Money:

And now, for the main attraction:

How much of QE2 has already been priced into the markets? This is a difficult question and any answer is necessarily subject to enormous uncertainty.  Nonetheless, we can use our estimates above to form a broad view in two steps:
First, we choose a date at which the market most likely started to price in additional easing.  Two candidate dates come to mind.  First, August 3, the day a Wall Street Journal article suggested that the Fed was about to set course for additional easing through the reinvestment of maturing/prepaid mortgage-backed securities (MBS).  Second, August 10, the FOMC meeting day at which the MBS reinvestment decision was subsequently taken.
Second, we go on to compare our “average” estimates of the effectiveness of QE1 with the observed changes since these two dates to form a view on how much of this easing was driven by the expectation of QE2—on the working assumption that the market expects additional asset purchases ultimately to total $1tr.
Before turning to the results, it is worth highlighting the limitations to which an approach as simple as this is subject:
First, it is debatable when the market started pricing in QE2.  The week between the August 3 Wall Street Journal article and the August 10 FOMC meeting—which also included our own August 6 call that we expected to see unconventional easing, probably with at least $1tr of additional asset purchases—appears the most reasonable choice.  An alternative would be Fed Chairman Bernanke’s August 27 speech in which he laid out the Fed’s options for additional easing.  The choice clearly matters for any view of how much the market has moved since then in anticipation of QE2.  Equity prices, for example, are currently only 3% above their early August levels—but more than 10% above their end-August reading.
Second, our estimates of the effects of QE1 are sensitive to the time horizon under consideration.  In particular, our models suggest that the equity and dollar effects build over time; for example, while we found no effect on equity prices on the day of announcement, the S&P appeared to have risen strongly after 30 days (the 30-day change and permanent “levels” effect equal +10% and +14% for a $1tr announcement of asset purchases, respectively).
Third, we compare our estimates of the effects of QE1 with actual changes in asset prices and thus do not take into account the influence of other asset-price “drivers.” For example, the direction of moves in Treasury yields in August could have reflected either expectations of QE2 or the impact of weaker-than-expected data on market perceptions about the economic outlook.  This, in turn, would make it difficult to disentangle one cause (QE2) from the other (economic weakness).  However, the September data mitigated this problem, as markets continued to behave as if QE2 was likely despite a better-than-expected run in the data.
With these caveats in mind, we draw three conclusions from the table:
First, the basic pattern of market moves is broadly consistent with growing anticipation of additional QE.  The middle part of the table shows the actual change in the GSFCI components and the 10Y Treasury yield since early August.  We see that financial conditions have eased substantially due to movements in all four components: lower ten-year Treasury yields, lower short-term rates, higher equity prices, and a weaker dollar.  The lessons of QE1 have thus been mirrored in the anticipation of QE2.
Second, while guessing the magnitudes is hard, the size of these asset price moves suggests that markets have moved quite far toward pricing the kind of program we expect.  In particular, a purchase program of about $1tr may now be reflected in 10-year Treasury yields, the three-month Libor rate and the dollar.  Spreads—defined here as the difference between the synthetic long-term yield in the GSFCI and the yield on ten-year Treasuries—have contracted less than suggested by the first round of purchases, at least so far.  (This might not be surprising given that spreads are much narrower going into the second round of purchases than the first.) Similarly, equity prices have risen less than the experience with QE1 would suggest.  This finding, however, is sensitive to when we think the market started pricing in QE2; equity price gains since Bernanke’s Jackson Hole speech have been more pronounced.
The view that the market has at least gone some way towards pricing in QE2 is consistent with a recent poll conducted by our fixed income sales team.  This survey polled 59 clients to find that 50% of participants expect more quantitative easing with an average amount (over all participants) of $500bn.  (This survey was conducted on September 21 prior to the last FOMC meeting and the recent speeches by Fed Presidents Dudley and Evans, both of which signaled a high likelihood of QE2 as early as November.  One would expect that participants’ expectations have risen in response to these events.)
Finally, the experience of QE1 is that the impact on assets tended to grow over time, even some time after the announcement.  This suggests that even after the moves seen to date, these trends could extend in some places.  Consistent with this conclusion, our market group expects more dollar weakness and moderately more S&P upside

In other words, plugging in a whole lot of data the Stuxnet 3000 recombinator prints out a matrix sheet which confirms that almost $2 trillion worth of QE2 has been priced in, while roughly $500 billion of discounted easing has already boosted stocks. Which means that should the Fed not announce QE2, or do some weak, BOJ-style piecemeal intervention with price-targets, that stocks will lose all their gains since early August, and bonds will collapse. So will commodities.

Then again, since the Fed controls the capital markets on the front and back end, all of this is irrelevant, and you just wasted 10 minutes of your life reading about the one outcome that will most certainly never happen.

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trav7777's picture

Oligarchy, bitchez.

they run things; we don't.

More Critical Thinking Wanted's picture

Then again, there are those who will say that using QE1 as a framework for any comparative efforts is useless, as QE1 had little to no effect.

The opposite appears to be true. Just the pure rumor of QE2 sent expected inflation up by a massive 0.5% in September:

A similar thing happened with QE1 - it has massive effects both on bonds and on the dollar - directly improving the global competitiveness of the US.

Even if we ignored all non-ZH data, given that back in the days ZH predicted imminent gloom and doom, EUR/USD parity, hyperinflation and a collapse (or nationalization) of banks, QE and the stimulus must have had some effect, right?

Furthermore, given the historic fact that advanced economies experiencing deflation also experienced crippling levels of unemployment:

Would it be responsible of the Fed to not act in some manner?

Or do you think 10% unemployment (10-15% effective unemployment) in the US is a good thing to have, the Fed should stay put and the US should voluntarily experience a decade or two deflation, in masochistic penitence for our past sins?

sushi's picture

In what way do you think that raising the cost of living for the unemployed will correct the problems facing America?

How do you see a ramp in equities benefiting the unemployed?

Do you believe that making it more profitable for US MNC to operate overseas will somehow create jobs in the US?


More Critical Thinking Wanted's picture


In what way do you think that raising the cost of living for the unemployed will correct the problems facing America?


How do you see a ramp in equities benefiting the unemployed?


Do you believe that making it more profitable for US MNC to operate overseas will somehow create jobs in the US?


An increase in expected inflation almost directly transforms into an increase in jobs: future inflation means future growth, which means an increase in demand and an increase in production - the usual business cycle.

An increase in jobs means the unemployed get a job, and can pay for the (nominally slightly more expensive) goods.

How does thi s work via equities and the FX rate? It works by making US businesses more competitive globally - giving US companies a larger share of global demand. This too strengthens job creation.

The problem for unemployed is that there is an inevitable lag for such effects to trickle - so it's already too late in many ways.

Spalding_Smailes's picture

I find it odd 5 billion in pomo can move the market 150 points but QE 2 starting at 1.5 trillion open ended  banker bailout is priced in?


Bear's picture

Pomo goes to Market, Queetwo goes to Piggy (, and we go wewewe all the way home.

Sudden Debt's picture

It's totally NOT priced in.  How can you price something in if you don't know the numbers?

500 bil., 1 tril, 2 tril, 7 tril?!


MarketTruth's picture

Exactly, it is not priced in. The Federal Reserve is using their retailer Goldman Sachs to try to CONvince the market that when QE2 comes to reality that the market does not abruptly move in the 'wring' direction. It is just another CON game folks. Just like having CONfidence in the market, CONfidence in the US dollar, CONfidence in the CFTC/SEC, CONfidence that GLD actually has gold, CONfidence there is gold in Ft. Knox, etc.

More Critical Thinking Wanted's picture

It's totally NOT priced in.  How can you price something in if you don't know the numbers?

500 bil., 1 tril, 2 tril, 7 tril?!

Did it occur to you to read the article you are replying to? In particular the following part, which was highlighted in bold letters by Tyler:

In particular, a purchase program of about $1tr may now be reflected in 10-year Treasury yields, the three-month Libor rate and the dollar.

So in Goldman's opinion 1 trillion USD appears to be priced in.

euclidean's picture

+1; while I am swayed that TD posts all this Goldman bullshit in jest, it is getting more and more prevalent.

Goldman were convincingly short the EU pair at 1.27 (both the apprentice and senior trading desks were adamant TD reported), now their EURO target is 1.55?? This must be saying they have anough TARP money in reserve to cover a 2800pip short position?

That's totally awesome!! I guess even on an 11 year timeline everything returns to a +ve growth. I'm waiting for more people to join Whitney in downgrading these useless banks.

Bolweevil's picture

Priced in? Oh we have yet to surpass our old friend 14,000 laddy.

monopoly's picture

It sounds like cash before this meeting. Not gonna sell my miners. But all else is already 0 and cash. Physical gold, just keep adding on any and all dumps.


Just tough to say if miners get thumped. What a freaking mess this is. And they don't even give a damn.

This will have an ugly ending.

Spalding_Smailes's picture

The Impact of Derivatives on the Gold Market
Jessica Cross – Chief Executive, Virtual Metals Research & Consulting
Paper Prepared for
The ABARE Conference, Canberra, March 2002

Back in 1994, after following what I called the derivative revolution throughout
the 1980s, I commented on this very issue. In my book1 I said…”what may
benefit an individual mining company does not necessarily augur well for the
market as a whole…. On occasions, producer hedging will not only influence
the price, but may even act as a major price determinant.”
There is general consensus now that derivatives have had a major impact on
the structure of the gold market and ergo, the behaviour in the price, in a way
that has not been seen in other commodities or financial instruments. Why
has the gold experience been unique? The explanation is due to a number of
factors. The market itself is very small relative to currencies, and any
structural change imposed on it had an exaggerated effect. But more
importantly, gold remains a contango market, exhibiting a positive carry.
Contrast this to base metals and the platinum group metals which can and do
lapse into periods of deep and prolonged backwardation; certainly long

enough to dramatically influence price risk management decisions. By remaining

in perpetual contango2, gold producers could rely on the positivecarry in a way that the mining communities of other commodities could not.
This basic premise then influenced the way the use of gold derivatives

This explanation begs the question: what is it about the gold market that
ensures a virtually permanent contango? The answer lies in the historical
purchases and holding of gold on the part of the central banks back in the
days of the gold standard. While pertinent when the Dollar and Sterling were
backed by gold, these holdings become less and less appropriate in modern
day financial management of reserves and currencies. The gold overhang,
held inertly, failed to accrue a return, and non-interest bearing assets no
longer have a place in current portfolio management theory.
Thus it turned out that, to earn its keep, these gold reserves were gradually
mobilised. The presence of this lending provided the liquidity necessary for
this existence and execution of price risk management products. Without
liquidity, the bullion dealing community would not have been able to execute
the transactions and hence they would have been render rather useless
unmarketable products. In short, the central banks as a source of this liquidity
became a key factor in evolution of the gold market.
Now none of this mobilisation of Official gold would have been encouraged if
there had not been a willing borrower of the metal on the other side of the
liquidity equation. Enter the mining companies, all greatly excited by the
1979/80 price rally to the magical $850 level, and hence flush with exploration

The 1980s also saw the advent of cost-effective heap-leach technology, which
improved dramatically the economics of mining relative low-grade shallow ore
deposits. The combination of these factors resulted in the ballooning of gold
output in Canada, the USA and Australia.

Note the marked increase in output from North
America and Australia during the 1980s. All this increased production, as it
rolled off the drawing board and into d’ore trucks, required project financing.
At that stage, US Dollar interest rates were comparatively high. The
differential between the cost of borrowing dollars and borrowing gold was
wide enough to convince the miners of the wisdom of the gold loan – the
original prototype derivative product. The miners borrowed gold from a bullion
bank, sold it to raise capital with the intention of paying it back through future
production from the developed mine. Once financed through metal borrowing,
this new output was subject to price risk, which the miner elected to managed
through increasingly sophisticated bullion base derivatives. This created a
very ready market for a whole range of derivative products for basic forwards
through to vanilla and then exotic options and any combination of these
products that one might care to imagine.


Samsonov's picture

mon, it appears gold and the miners were basically a weak dollar play since mid-summer.  Yesterday when the dollar found just a little support it was nasty thump for gold and simply brutal for miners (FCX being my skin in the game).  That reaction is what I call a warning shot; I dumped my FCX.

Bob's picture

Priced in . . . in other words, Mr. Market already spent money he didn't get yet.  Ironic, that.  Looks like a Market version of a McMansion: A McMarket.  Who pays the mortgage again?   

jeff montanye's picture

i'm curious if the equity market weakens does the treasury market rally as in '08?

Bear's picture

Good question. The movement of Treasuries (after QE2 announced) will be good indicator of whether QE was priced in ( in equities) correctly or not. If equities weaken and bonds don't rise the Market is toast. The long bond is now almost 135, it went up to 144 in Dec '08.

tahoebumsmith's picture

If so the Black Swan has arrived. If they lose their grip on the markets after spending another 3T the country will go into cardiac arrest.. Even though it's only a dead zombie anyway, it's all they got.O'l phd Ben will hit it with the paddles and there will be some jerking but it will be too far gone to revive.

JR's picture

Quantitative easing, a.k.a. accelerated counterfeiting, amounts to Wall Street looting Main Street, nothing more than “complex theft.”

Ayn Rand said that “only rational, productive, independent men in a rational, productive, free society” can be of value to one another.

“Parasites, moochers, looters, brutes and thugs can be of no value to a human being—nor can he gain any benefit from living in a society geared to their needs, demands and protection, a society that treats him as a sacrificial animal, and penalizes him for his virtues in order to reward them for their vices… No society can be of value to man’s life if the price is the surrender of his right to life,” i.e., survival.

FischerBlack's picture

I agree that a cool trillion of additional QE is priced in. But I don't agree that a cool trillion is all they'll commit to. It would be classic Bernanke to *not* put a dollar amount on the next round of QE but to leave it open-ended, free to grow  'as conditions warrant'. I don't think you'll see a sell-off on a commitment to expand the Fed balance sheet to infinity if needed.

Jeffrey Lebowski's picture

How the fuck could anyone have the hubris to make the statements this idiot has about shit being "priced in"..... Oh, never mind,m the jerk off is a "golden slacher"....nuff said

Dr. No's picture

Its all priced in.  Have you seen those prices lately?  With dow at 11k, and valuations in the toilet, something has to be included with those prices....

JR's picture

Exactly.  What I want to know is what’s priced out.

Hedge Jobs's picture

its priced in. just like peadophiles in charge of a kindergarten are going to fiddle with the kiddies the physcopaths at the FED are going to debase the worlds reserve currency.

carbonmutant's picture

Nothing gets past the beakers at Goldman....

tom a taxpayer's picture

If some powerful people think QE2 is priced in, then the October 8 stock market could be taking profits on the October 8 bad employment numbers. It would be a way for the stock market to send Ben the message "more QE milk, please". 

Or the October 8 market could rally. Or the market could fall and rally...and fall..and rally on a roller-coaster all day. Who knows. It just seems the world is on pins and needles...with currency jitters...systematic failures of mortgage foreclosure...etc. etc. If any day before Nov 2-3 is going to spark a fire, it is October 8 and the jobs report.


Seat belt fastened?  Check.

Crash helmet on?  Check.

Flotation device ready? Check.

First aid kit? Check.

Dramamine? Check.

Vomit bags? Check.

Change of underwear? Check.

Hdawg's picture

Just doing God's (cough Rothchild's) work.

Bless them all.

Shiznit Diggity's picture

These attempts to quantify the extent to which QE2 is priced in are misguided. Animal spirits running amok in a QE2-induced frenzy are not quantifiable. The sky's the limit, baby!

Assetman's picture

Whether or not we see QE 2.0 at a $1 trillion-- or some other unspecified amount-- the pricing in of this may be irrelevant over the next few months for the equity markets.

Why?  I think we see more economic deceleration due to an inventory effect going in reverse.  Earnings estimates are going to be well too high, and we may see pockets where selective stocks will be down 30%-40% in one day.  I'm seeing early signs of this already.  More is in store this earnings season-- but's it's gonna be widespread in the December quarter. 

Quantum Nucleonics's picture

The equity markets have always seemed to rally through the earnings seasons since the March '09 lows.  It will be interesting to see if this is quarter than breaks the pattern.

PeterB's picture

QEeezy Bag 2...bring it on or should I say up!

Quantum Nucleonics's picture

It's pretty silly to apply this quanitative (no pun intended) analysis to what is essentially a psychological, qualitative issue.  September's rally could have been short covering from August, or expectation for more QE, or expectations for the mid-term elections.  There are to many variables.  I could as easily have my 3-year old pick a number and be as accurate.

trip nixon's picture

The whole QE2 thing is nonsense, or should I say, the market reaction to it. QE2 would be an admission that QE1 failed, and that's somehow bullish? And that somehow means QE2 will succeed? Shouldn't something as important as the money supply and debt at least be something we can VOTE ON, instead of it being controlled by private interests.

What's the definition of insanity -- doing the same thing over and over again and expecting a different result. Well, my friends, this nation has gone INSANE.

bada boom's picture

It is nonsense, but these are people that believe QE1 was not big enough to solve the problem, so we must do more to fix it.

You cannot sail beyond the horizon because if you do you will fall off the edge of the earth.  How many times has society allowed misguided people to run the show?

To add to this. 

QE2 may be done for sinister reasons.  As we know, the federal reserve is not here to serve the American people, but itself.  Bernanke is the chairman, but he serves his shareholders.  What do his shareholders want?  Bernanke could just be a fool who was selected, sorry put up for vote, by his handlers.   You would select a fool that best fit yours means to the end.


gwar5's picture

The Fed has blathered on about it so much, of course it's priced in.

gerriek's picture

With the imminent crash traditional correlations will break down. Watch the dollar crash with the equity market.

slaughterer's picture

According to my models, equity markets are currently pricing in $4.8trillion in QE 2.0--but ... shuh...  don't tell it that. 

Bandwidthog's picture

Glen Beck made mention of zerohedge on today's program.  Glen gave zerohedge credit for the equity outflow article.  Good Job people.

RockyRacoon's picture

Great.  Can't wait for the influx of new readers -- and comments.


Hephasteus's picture

They don't need to downgrade McDonalds in australia. They got good managers.


Chicago bear's picture

Charlie Evans is giving a little talk in a couple weeks- before Nov 3. I'm eager to ask him the amount. Maybe I'll wear my ZH cap.

anony's picture

I always read the last paragraph of these long posts first.

So, not much time suck.

RockyRacoon's picture

I recommend reading the last part (episode 18) of Ulysses in order to avoid all the unnecessary previous text.

TexDenim's picture

I notice the dollar just spiked majorly.

I'll bet it's the Chinese buying greenbacks just to piss off the West for awarding the Nobel prize to a guy they keep in prison.

This QE2 anticipation is not going to end well.


GFORCE's picture

The year 2025 is mostly priced in.

99er's picture

(Reuters) - Japan said it will continue to intervene to curb a strong yen if necessary, just hours before G7 and IMF officials meet to discuss escalating tension over currency policies, and Thailand is also poised to act.

China, which has rebuffed calls from the West to let its currency rise faster, allowed the yuan to firm on Friday to its highest against the dollar since a revaluation in July 2005.

Traders said Beijing may be making some concessions ahead of International Monetary Fund and World Bank meetings this weekend. But they said any further rise would be limited so as not to harm its exports.

With positions entrenched, expectations for any meaningful agreement in Washington are low although fears of a global currency war have jumped to the top of the agenda.

George Costanza's picture

QE2 this and QE2 that.  Amazing how equity market no longer effected by earnings, PE ratio, and valuations.   That is very dangerous.

George Costanza's picture

QE2 this and QE2 that.  Amazing how equity market no longer effected by earnings, PE ratio, and valuations.   That is very dangerous.

George Costanza's picture

QE2 this and QE2 that.  Amazing how equity market no longer effected by earnings, PE ratio, and valuations.   That is very dangerous.