Despite the loud chorus of Wall Street strategists parading on a QE3 coming in September, we remain unconvinced that Ben Bernanke will indeed launch such another Quantitative Easing (QE) program anytime soon.
The Fed may take other incremental steps to stimulate the economy further, but the US economy simply is not despairing enough for the Fed to engage in another round of QE. Our view is that the Fed is primarily “talking up” the possibility of QE to prop up investor confidence. The prognosis for the economy and investor sentiment was much weaker in the autumn of 2011. Yet, the Fed nevertheless held its ground and did not launch QE3. Moreover, considering the looming threat of a “Fiscal Cliff” crisis later this year, the Fed needs to retain QE3 as the “last bullet” in its monetary policy arsenal. Using QE3 prematurely would diminish its effects on the economy and asset markets.
We believe that the Fed will launch QE3 only in at least one of the following circumstances: i) significant worsening in unemployment rate, maybe closer to 9% ii) severe correction in equities, or iii) USD strengthening to the extent that it affects the competitiveness of the US manufacturing industry.
That said, we do believe that QE3 is eventually inevitable, although not in the near term. The Fed is the only buyer capable of financing the burgeoning fiscal deficits in the US. Regardless of whether Obama or Romney wins the White House, it is basically impossible to close the fiscal gap materially given the rising entitlement obligations. Furthermore, any pick up in interest rates will easily choke off the US and global economy(Since the real estate and bond markets have priced in a 5 to 10 years period of ultra low interest rates.). Therefore, we see the US Federal Reserve as the buyer of last resort in the US Treasury market in the foreseeable future.