Obviously, it’s a little early to reach a verdict on QE3, but market pundit love reading the tea leaves early and often, so we figured we’d join the fun and look at early reactions.
First are the contradictory responses on the inflation expectations front. Even though TIPS and six year Treasury bond prices reflected higher inflation expectations, Monday saw a mini-crash in oil futures and an only partial recovery that day, with a further decline on Tuesday. The initial explanation, such as trader error to fears of releases from the Strategic Petroleum Reserves, omitted to mention that American oil use is still below 2007 levels and China is looking wobbly (even normally cheery Australians are beginning to think their Chinese ride is about over). But FedEx reducing its profit outlook seemed to focus investor minds on the lousy prospects for growth even after QE3. The GSCI was also down 2.2% on Monday (note oil is part of the GSCI, which tracks 24 raw materials; ). It fell a further 1.3% on Tuesday). Even Treasuries had regained over half of their initial QE3 losses.
Second, overnight, the Bank of Japan joined the central bank stimulus party, increasing its 45 trillion yen asset buying program by another 10 trillion. Asian stock markets and commodities rose, but not rip-roaringly, with the MSCI Asia Pacific Index up 0.6% and the GSCI up 0.4% as of this writing. Was this surprise move simply to keep the stratospherically high yen from going any higher in nosebleed terrain?
Third, some analysts are already discussing, meaning asking for, more QE. While Chicago Fed president Charles Evans favors setting targets for QE (meaning more, bigger QE as long as unemployment exceeds 7% while medium-term inflation expectations are below 3%) while Richmond Fed president Jeff Lacker is unconvinced QE will do little save increase inflation, this Bloomberg story gave more attention to the Evans position:
Now of course, there was some cheerier news, for instance, a Bloomberg story on how QE would help housing, and the wealth effect would help spending. It’s true that the wealth effect of home prices appreciation is stronger than that of stock price gains, and so in theory should do more for consumption. However, we’ve questioned how much this round of pushing secondary market bond prices lower will do for mortgage rates, since banks are choosing to increase their spreads over funding costs rather than lower interest rates and write more loans. There also may be a wee problem with a shortage of creditworthy borrowers (although the work of top mortgage analyst Laurie Goodman has highlighted overly stringent lending standards as an issue).
But even if you thought QE will help raise housing prices, it’s still an open question as to how that translates into consumer buying activity. Remember, in a balance sheet recession, businesses and individuals focus on shoring up their financial condition rather than exploiting opportunities (save maybe an iPhone splurge). So all the past norms on how housing price increases translate into a particular level of additional consumer spending are likely to be very much dimmed down. If your formerly $300,000 house, which went down to $230,000, is supposedly up to $245,000, are you really going to go out and spend more? You’ve still taken a hit on your net worth and are in catch-up mode.
As we keep saying, the first time a central bank tried lowering interest rates to increase asset prices as a way to stimulate spending was Japan in the mid 1980s. We know how that movie ended, and the Fed ought to. But despite the failure of the earlier QEs to do much more than goose asset prices, the Fed acts as if it can have a meaningful impact on the real economy when the central bank is already in ZIRP mode. It would be better if we were wrong, but we’re not holding our breath.