A Pros And Cons Analysis Of QE3

Tyler Durden's picture

From Peter Tchir of TF Market Advisors

To QE or not to QE, that is the question.

So here is what I expect to happen and why. 

The Fed will continue to re-invest proceeds from repayments. 

The Fed will use proceeds from pre-payments and redemptions to buy new assets.  If they don’t purchase new assets, they are effectively tightening.  Any time one of their treasuries matures, they will receive payment from the treasury.  This money has to be reinvested or else the Fed will have to remove some 1’s and 0’s from somewhere in the system, effectively, unprinting money.  So using the proceeds merely keeps the status quo. 
As part of this, they will also announce that they tend to purchase longer dated assets with these redemption proceeds.  They will argue that they want to add additional support to the long end of the curve specifically to help the mortgage market.  They may even go back to purchasing mortgages and not just treasuries.  The rationale of using the money to lend as much support to the mortgage market as possible is the most politically acceptable reason.  An unspoken reason for extending maturities will be growing concern within the Fed that this tool will be taken away, so to ensure the most control of their balance sheet they will want to extend their portfolio and reduce roll off going forward.

I believe the market has almost completely priced this in.  Any sign that they will not re-invest proceeds would be a negative for the market.  I’m not sure the market is pricing in any extension out the curve or into mortgages so those could provide mild upside.  I’m a little concerned that much of what I read and hear tends to view re-investment as a continuation of QE2.  I don’t see it that way.  Any re-investment of proceeds from a treasury redemption is merely keeping the status quo.  No new money is being created nor being pumped into the system, its no different than if the Fed had originally purchased this longer dated bond. 

QE3 will differ from QE2 and has only a 50/50 probability of being announced

On a basic level, the hawks within the Fed would like to pause the QE program at the end of June.  The doves are far more likely to be pushing for another round, but they seem less aggressive right now.  The economic data is much stronger than when QE2 was first announced, although it has been weakening of late, and the sovereign debt crisis in Europe has taken another leg down.  In an ideal world for the Fed, they would allow QE2 expire in June, but talk up the potential for QE3 in the event it is needed.  There are two problems with this approach.  One problem is that the Fed is well aware of the growing criticism of the policy.  Somewhere in the back of his mind, Ben, must be concerned that if he does not proceed with QE2 now, there will be too much pressure on the voting members to launch QE3 later.  If they don’t launch QE3 in June but the data deteriorates to the point they want to launch in September, the outcry might just be too strong.  The government as a whole is already against it.  Certainly the argument that ‘it worked’ would be difficult to make, the reality would be that just like so many other programs is that it increased current economic activity at the expense of future economic activity.  Also, since Ben is constantly trying to manage expectations, what would the market reaction be to a Fed that does not proceed with QE3 in June but tries to do it only a short while later?

So I think they might be pressured into launching a version of QE3 in June, but I think it will look very different from QE2.  I expect that it would target longer dated treasuries and possibly even mortgages, in an effort to create the most political support.  I also believe it will be more open ended.  Rather than saying we will spend $X billion in 6 months and here is our purchase schedule and target portfolio, he will create a ‘war chest’. QE3 will be positioned as we have $X billion that we are prepared to use to purchase longer dated treasuries and mortgages if and when we see the need to add support.  This would be a true compromise.  It does not force the Fed to create a schedule of auctions like QE2, in fact if the data remains stable they don’t have to do anything.  That should appease the hawks.  By targeting maturities that directly impact mortgage rates, its more palatable to the average American, and by keeping the activity less obvious they can deflect any links to inflation more easily.  It also keeps the purchases open at a time when there must be some real concern that this alternative tool could be restricted in the future.

I believe that the market is set up for some disappointment.  It feels like a lot of investors are saying they don’t expect QE3 but deep down think it’s likely and are positioned for the positive surprise.  Another group of investors seems convinced that no QE3 is priced in so are comfortable being long since only a positive surprise could happen.  In the end, I think a full QE3 announcement is mildly positive, a version of QE3 lite as described above is a minor negative, and no QE3 would be negative for the markets.

What the interested parties are pushing for

Ultimately Ben and the board will determine whether to pursue QE3 based on its merits, but there are a lot of interested parties that are pushing their agenda and likely have some influence on the outcome.  In the end, for all these reasons, believe that it is only 50% chance that QE3 is implemented, and if it is implemented it will have more flexibility than QE2 and a more concentrated effort to help mortgage rates.

Wall Street is for QE3

The QE program is great for Wall Street.  They will want to see it continue.  At the most basic level, the treasury is purchasing about $120 billion a month in treasuries from them.  If the street is making 1/8 on each trade with the government, that is $150 million of profit for the street every month.  For a product like treasuries, maybe an 1/8 is too much, but since the Fed doesn’t disclose the purchase price, just the quantity, it’s not a horrible assumption.  Asides from the direct bid/offer income made from the sale, the Fed is a dream client.  They are big, and tell you what they want to do.  If the street isn’t able to scrape out another 1/8 or 1/4, I would be surprised.  So I think we can assume that the treasury desks make another $200 million a month from trading ahead of the POMO schedule.  That is over $1 billion of additional profits for the street every quarter.  That is hard to give up.  From the earnings announcements so far, most of Wall street had strong revenues in their fixed income departments.  A part was certainly coming from corporate new issues, but with secondary volumes light across the board in corporates, it makes sense that a portion of that performance came from treasury trading related to QE2.

That $1 billion a quarter is just an estimate of the direct impact for the banks.  The extra $300 billion a quarter in money the Fed is printing has helped increase asset values and likely enhanced trading revenues on other desks as the money had to go somewhere.

So Wall Street would certainly prefer to see a QE3.  They would never tell the Fed these are the reasons, but its certainly in their interest to push for more QE.

New York Fed is for QE3

I am going to treat the New York Fed separately from the other Fed members.  First, their district benefits the most from QE.  Keeping Wall Street happy is particularly important for the New York Fed.  But I also believe that they like buying $120 billion of treasuries every month.  They are an important player in the market.  Wall Street traders who make multiples of what they do are finally at their beck and call.  Maybe its all subconscious but its hard not to believe that Dudley enjoys having Wall Street ‘need’ him.  The New York Fed gains prestige and the employees enjoy the power of wielding so much money, so they have a strong bias to maintain POMO.  They won’t say it, but buying bonds and dealing with the street all day, is a lot more fun than writing two year plans that no one will ever read or follow.

The Average American is against QE3

The average American cares about jobs, mortgage rates, and how much it costs to make it through a day.  The ‘success’ of QE2 has always mystified them.  They heard about job creation but never really knew anyone who got a job from QE2.  They heard it helped mortgage rates, but most had already refinanced, or are so underwater it doesn’t matter, so they assumed it must be working.  They have some stocks in their 401k, so that’s been good, but their company is threatening their pensions which is what they were really relying on anyways.  Nothing they heard about QE2 seemed to match what they were experiencing, but they let it go.  Suddenly the cost of making it through the day has been sky rocketing.  Their paycheck is the same, but gas, coffee, and food are all getting more expensive.  They are nervous about the prices they are paying for things and are starting to blame this QE thing for it.  They are also doubting it really did any of the good things people said it did.  This message is becoming louder and congress is hearing it loud and clear. 

Foreign Governments are against QE3

Regardless of what Ben says, other countries see QE as inflationary.  Regardless of Obama’s contention that speculators are pushing up the price of oil (in dollars) other countries see the QE policy as partly responsible.  China and other countries closely tied to the dollar as seeing inflation as a result and are not happy.  The U.S. is also not the only country experiencing minimal growth.  Other countries are too and the devaluation of the dollar is not helping their recovery.  Even strong countries like Germany must occasionally look up from the task of bailing out the PIGS and wonder what the consequences of a strong Euro will have on their economy down the road.  We have annoyed the world before, but usually we do that when we feel that we have the moral high ground.  With QE, I’m not sure that anyone can really hold their head high and argue with foreign governments that what we are doing isn’t short sighted and selfish.  This would be less of a concern if we didn’t need them to buy our debt and weren’t hoping that they won’t retaliate on the trade front.

Corporations are mixed on QE3

The impact to corporations has been mixed. 

The immediate impact to any company with overseas income has been positive as they translate those earnings back into weak dollars.  This is good so far, but may be temporary as other countries implement policies to fight the weak dollar.

Those that can sell overseas are benefitting from the weakness in the dollar as their products are more competitive.  The commodity companies are benefitting directly as prices of their selling prices spike.  Companies that have relatively low costs of input (technology) are also doing well; whereas, some manufacturing companies with intensive raw material usage are seeing pressure on margins in spite of increased opportunities overseas. 

So in general, corporations are slightly positive on QE as beneficiaries of the weak dollar but are growing concerned as they see margin pressure building.

The Fed is pro QE3

The Fed still feels like it is leaning towards QE3 but is being held back by fear of backlash from the average American, government, and foreign pressure.  Maybe they are even a little afraid they have unleashed inflation in spite of their denials that QE2 could in any way cause inflation – it merely caused the expectation of inflation which reduced the risk of deflation and made the whole world better.  If they knew for certain that they would be able to launch QE3 anytime they wanted to, they would definitely hold off, but I think they feel it would be prudent to put QE3 in place right now, even if on a limited basis, rather than having to restart the program – which could be very unpopular, and may cause us more harm then good if that flip-flopping behavior spooked the markets.

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King_of_simpletons's picture

The pros: Rich will get richer.

The cons: Main street will get a fatter rod up their arses.

thames222's picture

and the rich getting richer is a pro how???  and main street getting rammed up the arse is a con?  hmmm

 

www.forecastfortomorrow.com

Bicycle Repairman's picture

Hmmmm.  Looks like there will be more QE.  If they have to make the people beg for it, they will.

Henry Chinaski's picture

Painted into a corner.

It will be QE3.  Good point, though: It won't be announced so much.

Rainman's picture

...like the grease fart nobody heard coming. SBD

Dejean Splicer's picture

Of course Wall Street is for QE3.

"A Pros And Cons Analysis Of QE3"

Some might argue that it's all about the con.....

disabledvet's picture

i would argue "Wall Street is schizoid" on QE.  It both loves (secretly) and loathes it (secretly as well? the "no comment" is the scream of silence, no?) Clearly "the average American" is FOR QE 3 as he will not have to pay the true price of those goods he receives.  To be honest from "our commoner side of the coin" we must also agree that should QE 3 end then "prices must rise in order to reflect the reality of actually having to pay for the good."

LawsofPhysics's picture

If enough corporations see more QE impacting their margins, there will be no more QE.  However, since we have a GDP that is not based on actually manufacturing anything of real value, well, you get the idea.  More jawboning to come I'm sure.

Dr. No's picture

They may even go back to purchasing mortgages and not just treasuries

TBTF et al are out of treasuries.  There is no more need for the FED to buy them.  Infact TBTF wants treasurie prices to increase.  Do any TBTF still own mortgages?  If so, this would provde some support to the theory they will buy MBS.

Cleanclog's picture

I think they'll buy sov. debt and munis.

Dr. No's picture

Potentially.  We have seen this movie before.  The FED buys what the TBTF want to dump.  First it was toxic MBS.  Next, the FED surveyed the primary dealers on the amount needed for QE2.  My guess is the amount of QE2 was exactly the amount the TBTF need to realign their portfolios out of treasuries.  Next?  Just look at a TBTF balance sheet.  What is most toxic?  Could even be CC debt if TBT screams loud enough.  If there are no toxic crap on TBTF balance sheets, there will be no QE3. 

ZackAttack's picture

It's actually in the Fed's charter that it can't purchase munis with more than a 6 month duration.

I'm sure some kind of indirect Maiden's Hymen-type structure can be setup to workaround this pesky limitation, though.

Dr. No's picture

treasurie prices to increase

EDIT: treasury prices to DECREASE. 

Cleanclog's picture

And don't forget that Obama wants to be re-elected (and Bernanke wants to be re-appointed). QE3 or whatever the continued monetization program is called, enables more spending than austerity or inflation would - not to mention trying to prevent the rising costs of servicing government debt if interest rates rise.  

I concur that no specific program is likely to be announced.  But the Wall Street powers will know what's up and run the markets accordingly.  Fed will try to "slip" it past Main St minions.

SheepDog-One's picture

Lets see if they can slip it past China, who is now actively dumping dollar debt.

divide_by_zero's picture

+1 At some point China will likely rather take a virtual haircut now via the weaker dollar than wait until they need to make change for $10T dollar bill.

Cassandra Syndrome's picture

QE3: Hyperinflationary Depression

No QE3: Financial System Collapses

No QE3 would be less painful and quicker.

 

LawsofPhysics's picture

I agree.  Especially if China keeps buying our agricultural products.

SheepDog-One's picture

YES we're such a strong exporter of agricultural products....oh wait its not the 1980's anymore we're now a net importer.

SheepDog-One's picture

Economic data stronger yet weaker, build a 'war chest' of imaginary dollars....hmm yes I see. Well lets see how many are fooled by the now childish FED antics of doing QE3 but not announcing it, and how the toxic dollar reacts. Im sure the Chinese will be bamboozled by that super cunning move.

WTF why cant these people admit the FED is stuck and theyre at the end of the line? This shit isnt fooling anyone except the very dumbest people among us.

ghostfaceinvestah's picture

Oil at $140 will put an end to any further QE.

In fact oil at $110 will see that QE2 ends as scheduled imho.

ZeroPower's picture

Word.

However, will have to see if any sort of MENA peace (an oxymoron if ever there was one) would take it down to under $100.

At that point, still a chance for more stimulus.

equity_momo's picture

MENA violence is barely responsible for pushing the price of oil up. If the entire region sat down for tea and cupcakes tomorrow , oil might dip to 100 for a nanosecond - the only thing taking oil down hard for any significant length of time is an end to money printing or a global depression caused by higher oil prices resulting in demand destruction.  I believe we clearly have an oil supply problem but just see what taking Emerging Market growth out of the equation does to it : it'll push peak oil concerns out another decade or two.

ZeroPower's picture

If by barely responsible you mean $10-$20 then i'll agree. But whats $10 among friends right.

Oil already had its nice run from the ~$40 lows making it was back up to the 90s. But then its just flew up to where it is now, if you'll remember, only based on those very MENA troubles.

So again, depends on what you mean by barely responsible. In a world where $200+ oil is inevitable, this MENA situation won't even be spotted on the longer term chart. But until we get to those new highs, we must focus on the issues at hand surrounding the prices before getting ahead of ourselves.

equity_momo's picture

Just look at an oil chart since QE2 was announced : the trajectory was pointing towards where we are now regardless of MENA unrest. Its been a steady grind - the spike in Jan then went sideways until the relentless trend caused by money printing caught up.  Anyway , its semantics.

AR15AU's picture

This is rubbish. QE3 in any form will break the USD below 70 and unleash a panic... They need one more deflationary plunge before they can do this.

SheepDog-One's picture

Exactly. This idea of 'stealth QE' is for simpletons...China sees.

Bazooka's picture

i have not seen any comments here ar ZH about the fact S&P dividend yield being less than 2%...!!!

QE1, QE2 have not increased this to above 2% which would be bullish. Rather, despite these QE efforts, dividend yield has persistently remained under 2%.

Also, Mutual Fund cash holdings are near record lows...wow.

So, QE3 will only have harmful effects.

tomster0126's picture

What about oil at $150?  Peak is our biggest concern....also, as long as oil goes up, the dollar goes down. 

 

www.forecastfortomorrow.com

 

 

ZeroPower's picture

as long as oil goes up, the dollar goes down. 

Wrong.

Depends on America's monetary stance at that point, as well as whether we're in a liquidty providing (QE) environment. Hint: look at 07-08 run in the dollar coupled with the oil run.

SheepDog-One's picture

Right, and we're in such a stronger position now than in 08 with the dollar.

ZeroPower's picture

Indeed, weaker situation with dollar and oil is thus priced higher. If it was due to such high demand as in 07-08, then we'd already be through that $147 high. The demand simply isn't there as we all know the recovery is not in full effect... thus the negative correlation now btw crude and DXY.

Am confident this correlation will switch (as it has many times before) to positive once the printing madness stops.

Cassandra Syndrome's picture

Imo, peak oil happened when more oil was being produced than was being discovered about 30 years ago. That spread has widened substantially in the past 10 years.

Also, maybe coincidentally, the international petroleum exchange was founded in 1980. Did that help to keep prices artificially low as the divergence grew over that past 30 years? Are we upon the day of reckoning? Have the chickens come home to roost?

treemagnet's picture

Still doesn't matter - extensions of QE simply goose the carry trade and finally crush margins.  Same deal, it ain't sexy but when our debt is repriced for risk (now real), the jig is up.

slewie the pi-rat's picture

OMG!!! I'm Channeling Chairzelbub!!!

1/4% increase.  inflation is now vanquished!  goobermint must get spending under control.  we continue to see green shoots in spite of the fact that there are none.  b-bye!

equity_momo's picture

At the end of the day it doesn't matter who is for or against QE , the only metric that matters will be the market. The cost of international and domestic business priced in dollars against the purchasing power of the American consumer will decide how far QE goes.  Infinite QE is not a possibility with the correlation commodities have shown to money printing in the past 1 to 2 years.

ivars's picture

A little bit on a sad note:

I wonder what is Krugman writing now? On other hand, coming middle class Reich of the USA also sounds chilling. Within 10-15 years , Anschluss of Canada ( resources) , Mexico ( resources plus cheap labour/manpower). The Greater USA to counter the Great China.

Its a pity theories like Keynesian do not work long term and when they are needed they are finally disproved, especially if You are dealing in world reserve currency. Life would be much easier and nicer if they did work. But for some f.. reason they don't . And then we have nationalists coming to power, and neo-fascism as life saver for the USA, and neo-stalinism for China.

Why should it be so inevitable? Can it not be changed, somehow. Life tells it can not, as history repeats, and humans do not change, but if there was knowledge beyond this that would predict the ugly outcomes accurately and convincingly, would not people change their behaviour?

Anyway, the Reich of the USA ( by the way, there is also nationalist 4th Reich in Germany and surrounding regions coming as another superpower-again ) and neo-stalinist China will be.... Who knows if they will be worse of better than previous, its relative, but the numbers killed in potential confrontation will dwarf all previous wars.

How to stop that and still maintain some reasonable distribution of resources with every one happy. NO WAY, i do not see, so far.

 

GOSPLAN HERO's picture

A clandestine QE 3 is impossible.

Robslob's picture

Or just think like a rich person, therefore QE3 in our face...let them eat iPad2's!

treemagnet's picture

How does a drug dealer make his clients understand how important he is?  Answer: Cut 'em off briefly, let them experience "cold turkey", and they'll never question his dominance again.

Sudden Debt's picture

There is also the stealth option. Just create money and don't disclose the amount or maybe a small amount.

In the short end that would be bullish untill the sceme is uncovered. But that would take a few years.

We'd see the effects like inflation but they could blame in on the QE2 and of course the evil speculators and that would fit in with the words of Obama.

 

Robslob's picture

I get the reference but weed never really had that direct impact on me like QE does for bankers...

plocequ1's picture

Just bring it on already. Jesus H! This phony left -  right, Pro and con, right and wrong bullshit is bullshit. QE will continue. Done. 

AC_Doctor's picture

Ben can print more Bens and the US citizen gets bent over.

Financial_Guardian_Angel's picture

Let's not forget who is making the decision and what their interests are. These big boys need to take care of each other and their wallets first and foremost.

First, they need the QE3 to accomplish that. Secondly, they want to stay in power so must disguise QE as much as possible, not from the Chinese or other countries but from good 'ole dumbass JoeSixPack. So it will be hidden to prevent any backlash. They are quite vulnerable now because of the obvious correlation between QE and oil. Hey, the Dems need to keep Obummer in his seat and $6 gas won't git er done. If they pull back, equities tank and their Wall Street buddies scream bloody murder. So they will tell China to go pound sand (or perhaps rice), brace their own portfolios for what they know will eventually come, and hope they are on a tropical island with a trunkfull of gold before someone starts pointing the finger at them.

Sounds easy enough to sell to: Wall Street, top Dems and GOPers for that matter, TPTB, the TBTF, and anyone else with the golden rolodex.

ivars's picture

QE3 will not happen. USA is not alone in USD market. There will be warnigns of retaliation or retaliation from China, Oil producers, even Japan  ( but they are selling anyway under the disquise of quake funding needs) . UK?

I think FED will conclude that QE2 has achieved its targets ( spin, but with inflation they are correct) and increase the rates. It is not USA currency, its world reserve, and USA military has proven to be overstretched to take care of financial issues other than oil supply.

 

SilverRhino's picture

>> QE3 will not happen. USA is not alone in USD market. There will be warnigns of retaliation or retaliation from China, Oil producers, even Japan 

 

It's not the foreign devil that has them worried.   QE2 stops and all assets go into a nosedive until people are screaming and begging for QEIII ...

Meanwhile Asia will continue to lay hands on as much oil, PM's, food, resources to ride out this storm.    BTFD

ivars's picture

Except oil and chinese imports. That will not nosedive but grow faster and anyway take the economy, gdp, stocks with it. QE3 will not solve growth or stock market issues for more than 1 month since inception. so why start it?

slaughterer's picture

What the author proposes as the most likely outcome is a stealth QE3-lite targeting longer dated treasuries to support the mortgage market, with funds taken from re-investing old Treasury holdings or from a "war chest."  He thinks it will be a "minor negative" for the market.   He does not talk about the consequences of this on the market (PM, equity, bond, etc.), but the attitudes of various interested parties towards QE measures as they exist now, neglecting to go into detail about how counter-parties adverse to QE might react to QE3-lite.  This article seems a little too simplistic for me, but accurate and even ingenious in devising a stealth model that is the most likely compromise, if indeed the Fed compromises, which is not a given.