As we get closer and closer to the end of QE2 it’s wise to begin game planning for the potential impacts. The following are some goods thoughts from Glenview Capital regarding QE2 and lessons from QE1:
The first lesson we should take from 2010 is to respect the end of quantitative easing, either as an actual or psychological calendar event that could trigger a change in liquidity and economic activity. There are three reasons we should be concerned about the end of QE2 and the unlikelihood of QE3:
1) QE2 is set to expire in June, and it took seven months last time before a new round of quantitative easing was enacted. Thus, it seems reasonable to expect QE2 to lapse, particularly as the economy has rebounded and deflation seems contained as a risk (see #2).
2) US Fed Chairman Bernanke said in his most recent congressional testimony on March 1 that the “risk of deflation has become negligible.” If that is the case, it would be odd for the Fed to come forward four months later with further extraordinary monetary stimulus.
3) Two days later, the ECB President Trichet said that an increase in rates at the next meeting (April) is possible. Again, this doesn’t seem consistent with an extension of QE2 globally.
As such, we will be closely watching liquidity and economic conditions as the first elements of the unprecedented level of global monetary stimulus are withdrawn.
Second, we believe that the markets are next going to deal with the economic ball bouncing off the “right gutter” of inflationary pressures in early 2011. We already have seen extreme spikes in food and textile commodities, and since late August, the price of oil has risen 50% as a result of global demand and Middle East turmoil. Interest rates on the US 10-year Treasury bond rose over 100bps from the early October lows and, as described above, the tone and tenor of Central Bank commentary are now more weighted towards the risks of inflation.
Finally, it appears that the practical implications of a rising federal deficit ($1.3 trillion) in the US and a renewed emphasis on deficit reduction in Congress (not only the “Tea Party” but across both major parties) will likely slow the growth of both Federal and State/Local spending that has played such a key role in reinforcing the economy to prevent a double-dip recession. This is playing out in state legislatures in Wisconsin and New Jersey, in the President’s budget that calls for reductions in discretionary spending, and in the debates this month about extending the debt ceiling to accommodate additional federal deficits.
Taken together, these factors pose a complex scenario for our relatively simple and straightforward gutter guard scenario: just as the ball seems to be bouncing off the inflation gutter guard, both Congress and the Fed seem to be removing the left gutter guard. This is of course logical – if we want to fight inflation, we should first stop fueling it. However, it does beg the question – if the contemporaneous removal of extraordinary monetary and fiscal stimulus through the expiration of QE2 and a move to a more balanced budget does in fact slow the economy, will there be sufficient time, will and resources to re-establish a left gutter? Such is the danger of a zero interest rate policy, as it gives you little incremental room to provide incremental stimulus.
Source: Glenview Capital
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.