Saturday, August 8, 2009

Assetman Postulates on the Future of Quantitative Easing by the Fed on Zero Hedge

I always like hearing/reading other peoples ideas as to what's going to happen with the economy. We're in relatively uncharted territory when it comes to our current economic environment. Our historical perspective is limited by our personal experiences and how we've interpreted other interpretations of previous, similar events.

On the Zero Hedge post titled 'Is Quantitative Easing About To End?', Assetman posts his thoughts on what the future might bring:



by Assetman
on Sat, 08/08/2009 - 00:22
#30144

It will be very interesting to see what the Fed will do come September.

On the surface of things, investors have been "green shooted" half to death. We've been indoctrinated by MSM and the administration that the economy is on the mend. A continuation of QE will clearly imply that the Fed doesn't beleive in the "green shoots" theory... but it may well prop the markets up (at the expense of $).

The Fed could find another way to effectively moentize Treasury debt-- but it won't fool the currency markets at all, and the dollar would continue to erode. This is clearly something the Chinese don't want... and don't expect them to play the auctions, either, when it becomes inside knowledge.

The article suggests that removing QE would increase interest rates. Perhaps that may well be the initial reaction, as Treasury rates have clearly been subsidized at the long end of the curve.

But I think an equity market sell-off would neutralize that effect, as a natural flight to quality would take place. My sense that the Fed and those in the administration have been needing both a equity market rally and low rate levels to meet 2 different objectives. Obviously for the bond market, subsidized low rates have help keep mortgage rates low and has helped keep the cost of new issuance (and interest costs) at bay. The equity rally has allowed many of those with bad balance sheets to either restructure debt-- or to "equitize", as many REITS have effectively done.

In the end, I think the Fed will take the QE training wheels off in September. If the economy doesn't lose traction and another TBTF doesn't unwind, they keep the little wheels off and look for other toxic stuff to buy in addition to MBS (which they will continue to do in boatloads). But it will keep the dollar supported and the Chinese investors happy.

The end of QE could mean troubled times for equities, but I'm not sure about that. I think that all depends on whether Goldman and the other prop desks decide it time to make money the "other way". From a policy standpoint, enginnering as correction may not be a terrible idea, though... the flight from equities would likely move investors to Tresuries, allowing an absorption of additional supply-- while protecting the dollar from falling further.

The window has been open now for about 6 months for companies to come to market for additional capital. Perhaps the "green shoots" we are being told to believe in can keep the window open for an additional month or two. I don't think we are close to an inflationary event anytime soon-- unless the green shoots spread into something more self sustaining. While I beleive that removing QE makes the most sense at this point-- I wouldn't be surprised at all to see policy seeking to keep QE and erode the value of the dollar even more.