Citi Asks: "Are Investors Beginning To Price In QE4?"

While many investors and analysts are asking when the Federal Reserve will decide to hike rates again, Citi's Global Head of FX Strategy Steven Englander asks a rather different question: Are investors beginning to price in QE4?

He points out that economic data in the U.S. hasn't been very good (sans unemployment headline data), and that for every one positive data release, a series of disappointments follow. He points to the fact that Citi's economic surprise indicator has been dropping since mid-April as reflecting that reality.

US economic data have been soggy, other than labor market data, which means that we get one positive data release a month followed by a series of disappointments. This is reflected in the Citi economic surprise index (Figure 1), which has been dropping since mid?April and where a 0 level would be considered strong outperformance.

The note goes on to say that if investors are starting to price out a June/July rate hike, and are beginning to think that a hike is not likely until May 2017, then that would mean implicitly there is a probability that the economy is bad enough where a rate cut would be warranted. Incidentally, this is precisely what we warned about last August in "Japan's Dire Message To Yellen: "Don't Raise Rates Soon." It appears that Citi has finally gotten the message; we wonder how long until Yellen gets it too.

Considering the Fed downplays every time someone asks about negative rates, a return to the tried and true playbook and pulling out a "hail mary" quantitative easing program, or "QE4" would be the next logical step to get the economy going (in the minds of PhD's sitting in the Eccles Building that is).

My conjecture is that investors have begun to price out June/July hiking risk they are beginning to reject the view that there is a high?probability fed funds path that is as shallow as the market is pricing in. If you really think that a full hike is not likely until May 2017 (as is now priced in), you have to think there is a non?negligible probability that the economy is so bad that you would want to cut. Fed officials turn purple whenever anyone suggests that they might be facing negative rates and indications are that it would be supremely unpopular with the public.


Before you get to negative rates you would have the hail Mary of QE4 which would act mainly to push down long term yields. In the past the prospect of QE supported equity markets, but there is so much skepticism at this point that the equity market reaction is negligible and the brunt of the concerns are falling on USD and long?term yields.

The underlined is actually critical because it goes to the point made earlier by another team at Citi which asked what happens if the Fed did QE4 and nobody bought stocks. That, right there, would be the moment the Fed effectively priced itself out of both credibility and market manipulation; it would also be the beginning of the end for the current iteration of financial markets.

In any event, Englander he's still in the camp that believes there will be two rate hikes, he is a bit "puzzled" as to why others don't see things setting up for further rate hikes. Englander admits that if the data is so soft that investors can only justify one hike a year, there is also a probability that the Fed would want to implement QE4 as a tool to push rates down as a method of stimulating the economy.  

I am still in the two hike camp (along with Lockhart it seems) but am trying to puzzle through what the market sees that is so different. Bottom line if investors see the data as so soft as to justify only one hike a year, they also see the probability distribution of outcomes as encompassing negative rates in theory and QE4 in practice. The implications of this perceived risk are playing out in FX and FI markets.

Recently the DXY broke its 100dma to the downside, reinforcing the above point.

And relative to Japan, who is actively pursuing NIRP, U.S. yields have quite a bit of room to fall further if a veiled NIRP is unleashed in the U.S. via a QE4 program, which as so many "leaders of thought" in the US have already opined is a much more preferable way of pushing if not earnings then at least P/E multiples higher.

With persistently soft economic data, and with Citi themselves warning that there could be even further weakness to come, it would come as no surprise to anyone (at least for those that read Zero Hedge) if the Federal Reserve reversed course and unveiled NIRP in QE4's clothing, while simultaneously ridding banks of those risky energy loans the Dallas Fed claims nobody is worried about.