Market wants QE4. Fed should say no.October 2, 2012: 12:21 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
When it comes to quantitative easing from the Federal Reserve, the market is singing the refrain from Depeche Mode's first big hit song: I just can't get enough!
It was only two-and-a-half weeks ago that the Fed unveiled its third round of quantitative easing, an open-ended plan to buy $40 billion of mortgage-backed securities a month. Economists at Goldman Sachs estimate that QE3 could wind up lasting until the middle of 2015, and hit a final price tag of $2 trillion. Yet Wall Street wants even more liquidity.
In a report last week, Morgan Stanley chief U.S. equity strategist Adam Parker wrote that "QE3 will likely be insufficient to significantly boost equity markets and we wouldn't be at all surprised to see the Fed dramatically augment this program (i.e., QE4) before year-end." Parker suggested that the Fed could simply boost the size of the monthly mortgage-backed security purchases in QE3 to add further stimulus to the market.
But strategists at Pavilion Global Markets, a brokerage firm in Montreal, took the concept of QE4 a step further. In a report released Tuesday, the Pavilion strategists argued that the Fed could begin to buy even more longer-term Treasuries again.
In other words, QE4 (or should we call it QE Quattro? QE3+? QE4Ever? QE ∞?) would look more like the first round of QE and QE2 and could add more support to long-term bonds once the Fed's Operation Twist program (in which the central bank is selling short-term bonds to buy ones with longer maturity dates) expires at the end of this year.
Sure, Fed chairman Ben Bernanke has continued to preach the tried-and-true central bank gospel about all this stimulus, namely that low rates won't lead to runaway inflation.
But hopefully, even Bernanke (who we should perhaps call a deflation hawk instead of inflation dove) has to realize that the Fed can't justify another round of money-dropping this soon ... even if jobs growth in the United States remains tepid and the nation inches closer to fiscal cliff diving at the end of the year.
Parker conceded in his report that the risk of further rises in commodity prices are a bit of a concern, but he ultimately dismissed worries that QE3 would send the price of oil and gold that much higher.
The Pavilion strategists were more concerned about the continued pressure on long-term interest rates, which are already near all-time lows, and expressed worries about what might happen to lending if more easing led to negative interest rates for short-term bonds. We're almost there. The yield on a 3-month Treasury bill is just 0.08%. And with the 10-year Treasury at just 1.6%, do we really need rates to keep going down? To what? Japan levels below 1%? How's that working out?
As I've said in this column time and time again, the lack of cheap financing for loans is not the biggest problem facing the U.S. economy.
"Is the economy as strong as everyone would like at this stage? The answer is obviously no. But while the Fed has done what it can, there is not much more that it can do," said Kate Warne, chief investment strategist with Edward Jones in St. Louis. "The Fed is not the one that's constraining economic growth. Anyone looking for QE4 is forgetting that monetary policy is not tight."
If the Fed wants to justify yet another dose of QE, it can't keep trotting out the need to keep rates low card. Let's call a spade a spade here. The Fed seems most worried about the possibility of another recession if Congress does not reach a deal to avert the fiscal cliff. That's why Bernanke may need to act again.
"When people talk about what the Fed will do next, I think the Fed does need to remain accommodative," said Leslie Barbi, head of fixed income for RS Investments in New York. "But I question why the Fed had to pull out the big guns now. It looks like it doesn't want people getting nervous about downside risk."
But Barbi thinks the Fed is now locked in a dangerous dance with the market. She is worried that the Fed is now getting too boxed in. Investors expect the Fed to bail out the market all the time. Eventually, that's going to lead to inflation, no matter how much Bernanke claims it won't.
"The Fed's credibility is starting to get a little tattered around the edges," Barbi said. "The Fed is trying to have their cake and eat it too. It seems like they want to tell people they will keep easing even after the economy improves but also tell them that if they need to fight inflation, they will. That's a conflict."
Warne added that investors need to remember there is typically a lag of several months before Fed actions have a meaningful impact on the economy. So if, for example, the September jobs numbers that come out on Friday are awful, that shouldn't be considered a good reason for the Fed to fire up the QE oven once again.
However, Warne also said that the Fed's hands are tied. If the economic data between now and December deteriorate further and stocks begin to sell off on that news, Bernanke may have no choice but to placate investors.
"The Fed does not need to do more at this point. It is way too soon to know what the impact of QE3 will be," she said. "But is there some chance that the Fed will do something again before the end of the year? Absolutely."