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The Odds Of More QE?

  • Written by Syndicated Publisher 1 Comment1 Comment Comments
    May 8, 2012

    A friend sends me the following chart to support his conclusion that another round of QE is coming from the Fed sometime in June. The chart tracks the ten-year bond and the performance of the S&P since 2009.

    Some thoughts on the info provided in this graph:

    +While both QE1 & 2 were ending, the S&P fell.

    +Operation Twist appears to have successfully restrained any increase in long-term interest rates.

    +The European Long Term Financing Operation (LTRO) liquidity operations had a significant positive impact on US equity prices.

    +As of today, the spread between LT interest rates and the S&P is the widest it has been in three and a half years.

    + The current level of the ten-year bond is the same as it was during the height of the recession/depression during the 1Q of 2009.

    My observations:

    – Tyler Durden at Zero Hedge (among others) has been pounding the table with the thesis that what drives markets today is not the size of the Central Bank balance sheets, it is the daily/weekly flow of additional monetary easing that matters. I think the chart confirms this.
    – Twist and LTRO are finished for the time being. Bond yields are reacting to the economic slowdown that comes with the ending of these monetary jolts. Stock markets around the world have flattened out; there is good evidence that an equity market correction is underway.
    – The huge gap in the current spread between bonds and stocks is scary. Notice that the orange and white lines have crossed numerous times in the past. If the lines were to cross again, it would imply that either interest rates have to shoot up, or the stock market is looking at a very sizable adjustment. I see little chance for interest rates to move higher in the current environment. This sets up the possibility for an out-sized down move in stocks.


    – Everyone (most importantly Bernanke) is aware of the information that is contained in this chart. Bernanke is also aware of Durden’s point: you have to feed the beast every week, and you have to commit to weekly feedings far into the future, or markets will get grumpy.


    – The expectation from all directions is that the Fed and the ECB will (once again) rise to the occasion (June is the popular time frame), and when they act, stocks will go “green” again.


    – That the market is so convinced that the Fed will bail it out (or prevent any significant decline) allows for the very high spread between stock prices and interest rates that exists today. There is a high degree of complacency in the market. It believes the Fed is the backstop, and it will always be there when markets flutter.

    The arguments and logic for additional Fed accommodation are compelling. The assumption is that the Fed will do the “logical” thing and repeat its past actions . I disagree.

    The next opportunity for the Fed to act is June 21. That is 133 days before the election. Any new Fed program (sterilized QE) would take time to become operational. To be effective, it would have to have a time frame of at least six months. This leads to the conclusions that (1) the earliest the Fed could act is late August, and (2) if it were a six-month program, it would be in full gear for the first week of November.

    The Fed can’t do that. It would (appropriately) be accused of supporting Obama and interfering with the political process in the US. An independent Fed can’t throw elections. If it tried, the result would be a lose of its independence.

    The Fed’s only support comes from the political right. I think this is because the Political Right = Money, and Money “believes” it is better off with an independent Fed. If the Fed takes action to support a liberal president in a key election, it will lose what support it has.

    The folks at the Fed ain’t dumb. If they cared about their role in society and wanted to maintain their power, prestige and independence, the last thing they would do is start another round of QE in the 3rd quarter of 2012.


    The situation is quite the opposite in Europe. I think the outcome will be the same. Europe has had its critical elections this weekend. Now we know that a Socialist will lead France. The message from this election is very clear. The French people do not want austerity. Neither do the Dutch, Italians or Spaniards. The only country left that is pushing for austerity is Germany.

    I think that there is a near zero chance that the German people will permit their leaders to write a check that supports growth programs in the EU. If France says, “To hell with austerity”, the politics in Germany will turn away from those that support pan European bailouts. Merkel will be D.O.A. if she tries to have Germany foot the bill for a French expansion program.

    I will add that if France does turn its back on austerity, (almost certain that they will) the German Bundesbank will just say, “Nein, danke”. Without “Bubba”, no deals will happen.

    The markets are going to hit a wall on Monday. There will be a cry from the pundits,

    “Don’t worry, QE is coming for sure! Buy the dip! The Fed is going to come to the rescue and bailout the global markets!”

    I’m going to go against the consensus opinion.  

    The Fed is on hold until December.  


    We will not see another LTRO operation this year. 

    If I’m right, what does it mean for those lines on that chart?Nothing good.

    Images: Flickr (licence attribution)

    About The Author – Bruce Krasting

    I worked on Wall Street for twenty five years. This blog is my take on the financial issues of the day. I was an FX trader during the early days of the ‘snake’ and the EMS. Derivatives on currencies were new then. I was part of that. That was with Citi. Later I worked for Drexel and got to understand a bit about balance sheet structure and corporate bonds from Mike Milken. I was involved with a Macro hedge fund later. That worked out all right, but it is not an easy road. There was one tough week and I thought, “Maybe I should do something else for a year or two.” That was fifteen years ago. I love the markets. How they weave together. For twenty five years I woke up thinking, “What am I going to do today to make some money in the market”. I don’t do that any longer. But I miss it.


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