Friday, May 25, 2012

No More QE in June?!?!

Bottom Line:  The data flow is soft, but Dudley indicates it is not soft enough to ease.  And while some are pointing to falling TIPS-derived inflation as  given the Fed room to move, they have traditionally delayed until conditions are more dire (they are not exactly prone to overshooting in the first place).  The Fed doesn't think they will ease further; they think their next move will be to tighten.  Which means that financial conditions will need to deteriorate dramatically to prompt action in June.  So if you are looking for the Fed to ease in just four weeks, you are looking for financial markets to turn very, very ugly.  Lehman ugly.  And I wish that I could say that it won't happen, but European policymakers are hell-bent to push their economies to the wall while worshipping at the alter of moral hazard.
Read it at Tim Duy’s Fed Watch
Is QE3 Just Around the Corner?
By Tim Duy

I think Tim is correct in noting that market participants are expecting too much if they believe another round of QE is coming in June, absent some large disruption. However, a couple points seem off the mark. At the open Tim quotes
From the Wall Street Journal today: In "QE," the Fed pumps money into the financial system through asset purchases.
Depending on one’s definition of the “financial system” this may be correct, but the wording seems to imply inflationary money printing, which QE is not. As I wrote last year in Deflationary Monetary Policy:
Common conception is that quantitative easing is inflationary money printing. However, as noted earlier, quantitative easing (as practiced) is strictly an asset swap between the Federal Reserve and banks. Operationally, QE2 simply involved the Fed exchanging interest-bearing Federal Reserve notes for treasury notes. [Private] Net financial assets were not actually increased during this process. Quantitative easing therefore involves no money printing, simply swapping assets.
Separately, as Tim’s title implies, most people are calling the next round of quantitative easing QE3. Shouldn’t any further QE be considered QE4? Currently the Fed is engaging in Operation Twist, which apparently is not QE3. However, the next round, if it happens, is rumored to be sterilized QE. Since Operation Twist Doubles as Sterilized QE, applying the same logic implies that the next round should either not be considered QE or should be QE4. (I recognize this is nitpicky but think it’s important to keep track of all the Fed’s efforts)

Unfortunately for investors the market direction in coming months likely hinges, to a large degree, on the Fed’s actions. The Fed's Treasury purchases are now about asset prices, having accomplished little for economic growth since the first QE. With a Presidential election approaching, the Fed will likely err on the side of caution to avoid the perception of taking sides. Therefore, if the Fed doesn’t act in June, absent a collapse, it may not act at all in 2012.

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