FT hijacks HA’s QE2

Has the FT been reading HA?  You heard the title “QE2” – given for the reloaded cartridges that will facilitate money printing round 2 by the Fed, ECB and BoE – 6 months ago right here on HA.  If the mainstream is catching on now, it’ll be another 2-4 months before it is implemented, which takes us to Sep-Nov 2010. 

It is not a matter of “whether” it will happen, it is a matter of “when.”

QE to infinity!  The only protection for your savings is owning gold.

 See “QE2 and its implications for the Rand” if you’re interested in the implications of QE2.  Following article was published in the Financial Times over the weekend.

QE2: investors braced for the sequel

By David Oakley and Michael Mackenzie

Published: July 23 2010 18:43 | Last updated: July 23 2010 21:14

Investors looking for reassurance that the global recovery is on track would have drawn little comfort from central bankers this week.

First, the Bank of England’s interest rate-setting committee revealed that it was worried enough about anaemic growth to discuss pumping money into the economy again.

Then Ben Bernanke, Federal Reserve chairman, said it, too, stood ready to act to head off another slide into recession.

Equities tumbled in response, then rallied. By Friday, when figures showed the UK economy to be bouncing back more strongly than expected and the results of European bank stress tests were published, markets looked more settled.

The bankers’ message had been carefully nuanced: “unusually uncertain”, the phrase Mr Bernanke used to describe the economic outlook, was intended to show that the Fed was alive to the consequences of weakening growth, rather than alarmed.

Nevertheless, for the first time since policymakers earlier this year put on hold the policy of quantitative easing – buying government bonds and mortgage-related securities to expand the money supply and stimulate lending – it is back on the agenda.

The return of QE, were it to happen, could have far-reaching consequences for financial markets. Even more so second time around, according to analysts, because the risks associated with embarking on another round of easing would be that much greater.

Tom Porcelli, US market economist at RBC Capital Markets, says: “If central bankers restart quantitative easing, the stakes would be higher than ever before.

“It would not necessarily settle the markets and could lead to a serious bout of market volatility. Investors might have to brace themselves for a rollercoaster ride.”

John Wraith, fixed income strategist at BofA Merrill Lynch Global Research, says: “It won’t necessarily be like the first time when the government bond markets, and indeed the equities markets, were boosted by the actions of QE.”

Analysts say that restarting QE would lead, initially at least, to a drop in government bond yields as the increased competition from central banks buying debt pushed up the prices of bonds.

That is assuming the scale of central bank action was similar to that of the original QE programmes launched in March last year. Then, the US and UK announced initiatives in which the Fed bought $1,750bn of government bonds and mortgage-related and agency securities, and the Bank of England purchased £200bn ($308bn) of mostly government debt.

Before long, though, bond yields could start rising again if investors started worrying about the inflationary impact of the banks’ actions.

For now, fear of deflation remains high. It has led to a sharp decline in US Treasury yields, with the 10-year note hitting 2.85 per cent this week, down from 4 per cent in April.

Inflation expectations have tumbled, falling to around 1.70 per cent for the next 10 years, from a peak of 2.40 per cent in May.

But renewed quantitative easing might change that. A rise in yields could, in turn, deter overseas investors who have bought Treasuries, and even gilts, on the grounds they were a haven from the eurozone debt crisis and the threat of a double-dip recession.

For the smaller UK economy, the risks of another round of quantitative easing are greater, not least because sterling, unlike the dollar, is not a reserve currency. Pumping more money into the economy could add to concerns about the UK’s triple A rating if the long-term consequence was to drive up the cost of borrowing and make it more expensive for the government to pay interest on the record amounts of debt it has issued.

The reaction of the bond markets would be important. Apart from expanding the money supply, the intention of QE was to ease credit conditions in the economy. If government bond yields fell, it would follow that borrowing costs for companies and households should also fall, boosting activity and a wider economic recovery.

In the US and UK, short-term bond yields are near record lows, raising the question of how much further they would fall were the central banks to act.

The Fed and the Bank of England are likely, therefore, to be cautious. Fresh quantitative easing is only likely if growth deteriorates markedly and a double dip begins to look inevitable.

As Friday’s GDP figures showed, this is far from the case in the UK. Second-quarter output was stronger than expected, rising 1.1 per cent from the previous three months.

Moreover, UK interest rate futures markets are, in effect, pricing in a rise in the Bank base rate from 0.5 per cent to 1 per cent by the middle of next year. That suggests investors think recovery is more likely than the double-dip recession.

In the US, the picture is more mixed. Interest rate expectations suggest markets believe the Fed funds rate will remain between zero and 0.25 per cent over the next year. Though most analysts forecast growth in 2010 will rise to above 3 per cent, there appears to be little prospect of imminent monetary tightening.

Paul Ashworth, senior economist at Capital Economics, says: “The bottom line is that monetary policy isn’t going to be loosened any time soon. The best that can be said is it isn’t going to be tightened for a couple of years either.”

Still, Mr Bernanke was clear in his testimony to Congress on Wednesday. Another round of quantitative easing should not be ruled out. QE2 is probably a last resort for the Fed and the Bank of England, but the odds against it have shortened this week. Investors should be prepared.